Nearly three-fourths of U.S. states don't tax Social Security benefits at all, although your Social Security benefits can be taxed by the IRS regardless of where you live. Here's a quick guide to the 37 states that don't tax Social Security benefits, how Social Security is taxed on the federal level, and what you need to know if your state isn't on the tax-free Social Security list.
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Most states don't tax Social Security benefits
Here's the easy answer: If you live in one of these 37 states (or Washington, D.C.), your Social Security benefits aren't taxed on the state level. They may, however, be subject to federal income tax, which we'll get to in a minute.
Data Source: Author's research.
How much federal income tax could you pay on Social Security benefits?
It also is important to point out that just because you live in a state that doesn't tax Social Security benefits, you still may have to pay federal income tax on them, regardless of where you live.
Specifically, the IRS uses an income test to determine if a portion of your Social Security benefits are taxable for federal income tax purposes. The IRS defines your "combined income" as one-half of your Social Security benefits and all of your other sources of income -- even non-taxable bond interest is included in this figure.
Here are the three key rules:
If your combined income is over $44,000 (married filing jointly) or $34,000 (all other filing statuses), as much as 85% of your Social Security benefits can become taxable income.
If your combined income is over $32,000 (married filing jointly) or $25,000 (all other filing statuses), but below the 85% threshold, as much as 50% of your Social Security benefit can be taxable income.
If your combined income is below the 50% thresholds, your Social Security benefits are not taxable.
Generally speaking, this means if Social Security makes up the vast majority of your retirement income, your benefits will not be taxable. However, if you have substantial income from other sources, you could end up paying federal income tax on your Social Security benefits. And under no circumstances will more than 85% of your Social Security benefits count toward your taxable income.
Here are the 13 states that do tax Social Security benefits
It also is important to point out that the states that tax Social Security benefits don't all follow the same income test and rules as the IRS. In fact, only four do -- Minnesota, North Dakota, Vermont, West Virginia.
The other nine states -- Montana, Colorado, New Mexico, Utah, Nebraska, Kansas, Missouri, Connecticut, and Rhode Island -- all have their own rules when it comes to taxation of Social Security benefits, and some can be quite complex. For example, New Mexico gives Social Security beneficiaries a deduction, but the amount of the deduction and income limits for the deductions vary by age. Be sure to look into your state's rules if Social Security benefits are taxable.
Just one piece of the puzzle
There are many factors that determine how retiree-friendly (or not) any given state is, and while taxability of Social Security benefits is certainly one factor, it's a relatively small part of the big picture. Many states that don't tax Social Security benefits can be tax nightmares otherwise, while some of the states that do tax Social Security are actually quite tax-friendly in other ways.
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