Are Your Social Security Benefits Subject to Double Taxation?

Social Security is arguably the most important social program in this country. More than 62 million people each month receive a Social Security check, with some 22.1 million of these recipients being pushed above the federal poverty line as a result of their guaranteed monthly payout.

Yet Social Security is also rife with misunderstandings.

For instance, one of the longest-running unknowns is whether those currently receiving benefits are seeing their payout lessened through what's known as "double taxation."

Are Social Security benefits being double taxed?

As the name implies, double taxation is when the same base of income or money is being taxed twice.

As a real-world example, publicly traded companies earn a profit from their normal operating activity then pay corporate income tax to the federal government on that profit. Some or all of this profit can then be disbursed to shareholders as a dividend. This dividend is counted as income when individual or married taxpayers file their federal income tax and is therefore taxed again, depending on your marginal tax bracket. That's the same base of money being taxed twice, and it's a perfect example of double taxation.

But are Social Security benefits subject to double taxation? Well, the answer is yes and no. It really just depends on your unique situation.

First, let's look at the thesis for those who claim that Social Security benefits are being subjected to double taxation.

The idea here is that the federal government is subjecting earned income of up to $128,400 (as of 2018) to a 12.4% payroll tax. Then, once a retired worker begins to receive Social Security benefits, if their adjusted gross income (AGI) plus one-half of their Social Security benefits exceeds $25,000, or $32,000 as a couple filing jointly, half of their benefits can be taxed at the federal level. It's worth noting that a second tier exists for individuals and couples filing jointly earning in excess of $34,000 and $44,000, respectively, that results in up to 85% of Social Security benefits being taxed.

Therefore, the complaint is that earned income is being hit by the payroll tax and then Americans are also being hit during retirement by the taxation of benefits.

Is this actually an instance of double taxation? Not exactly -- and I'll explain why.

In a traditional sense, double taxation isn't happening

To begin with, you have to understand that while the payroll tax is an indispensable income generator for Social Security -- it generated $873.6 billion of the $996.6 billion collected in 2017 -- it's not the only source of revenue. Interest income earned from the program's nearly $2.9 trillion in asset reserves created $85.1 billion in interest income last year. The taxation of benefits also provided for $37.9 billion in added income. In other words, not all income generated by the program is derived from taxation, which throws out the broad-based notion that all Social Security benefits are being double taxed.

Further refuting this thesis are statistics from the Senior Citizens League, which finds that 56% of senior households are currently paying tax on some portion of their Social Security benefits. While this is significantly higher than the 1 in 10 households paying tax on a portion of their benefits when introduced in 1984, it still shows that 44% of all senior households owe no tax on their benefits.

However, there are instances in which the double taxation of Social Security income does exist.

If you live in these 13 states, then you might be double taxed on your Social Security income

Aside from the federal government taxing benefits once they reach a certain income level, 13 states also tax Social Security income to some varied degree. Depending on your AGI, you may be dually subjected to state and federal income tax on your Social Security benefits. That's the same base of income being taxed twice, which is the exact definition of double taxation.

In alphabetical order, the 13 states that currently tax Social Security benefits are:

  • Colorado
  • Connecticut
  • Kansas
  • Minnesota
  • Missouri
  • Montana
  • Nebraska
  • New Mexico
  • North Dakota
  • Rhode Island
  • Utah
  • Vermont
  • West Virginia

Now, if you live in one of these 13 states, it's far from a guarantee that you'll face double taxation. For instance, Missouri doesn't begin taxing Social Security benefits until $85,000 in AGI for single filers and $100,000 in AGI for couples filing jointly. For Rhode Island, it's $80,000 and $100,000 in AGI, respectively, for single filers and couples filing jointly. You'd have to be a well-to-do senior to be double-taxed in these states.

Meanwhile, a handful of states mirror the federal tax schedule of Social Security. If you live in Minnesota, North Dakota, Vermont, or West Virginia and you owe federal income tax on your Social Security benefits, then you're going to owe state tax on those benefits, too. In this instance, you are in fact facing double taxation, and it stinks!

Unfortunately, with Social Security facing an estimated $13.2 trillion cash shortfall between 2034 and 2092, it's not as if taking the taxation of benefits off the table is an option. Doing so would reduce annual income and put the Social Security program in dire straits.

In other words, while a majority of Social Security recipients won't face double taxation, it will be a reality for some beneficiaries in select states.

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