Hate Taxes? 37 States Make Social Security Tax Free
Dan Caplinger, The Motley Fool
Updated
Over the course of your career, you'll probably have tens of thousands of dollars in Social Security payroll taxes withheld from your paychecks. Workers are confident that by paying those taxes up front, they'll be able to collect Social Security benefits for the rest of their lives when they decide to retire, and that's a fair trade-off for the financial security and peace of mind that those benefits will give them.
Shockingly, the federal government forces some Social Security recipients to include a portion of their benefits in their taxable income. That's offensive to those who feel like they've already paid their taxes to earn those benefits. However, taxpayers can at least take some comfort in the fact that the vast majority of states don't add insult to injury by adding state income taxes on what their residents get from Social Security. Below, we'll look at taxes on Social Security more closely to see what you can expect -- and a move might be smart.
Social Security card embedded in spread-out pile of U.S. currency.
Image source: Getty Images.
Why you might owe federal income tax on your Social Security
The federal government has rules that it uses to figure out whether you have to pay tax on your Social Security benefits. Only those recipients who have countable income above certain limits have to worry about benefit taxation at all, and even for those who are subject to the tax, only a portion of those benefits are counted.
There are two key things to keep in mind:
For purposes of determining income for Social Security taxation, you have to take your income from non–Social Security sources and then add in one-half of what you receive in benefits for the year.
The initial threshold numbers are $25,000 for singles and $32,000 for joint filers, above which you might have to include up to half of your benefits as taxable income. Above higher thresholds of $34,000 for singles and $44,000 for joint filers, up to 85% of Social Security might end up getting taxed.
Bucking the IRS
You might expect state governments to follow suit in taxing Social Security. After all, most states are hurting to generate enough revenue to keep budgets balanced. However, many states work hard to give their retiree residents financial incentives to stay in state after the end of their careers in order to help support their local economies. Hammering retirees with a state Social Security tax isn't the friendliest way to keep residents from fleeing to less taxing jurisdictions.
As a result, you'll find 37 states -- along with the District of Columbia -- that don't impose any state income tax on Social Security.
These states don't tax Social Security
Alabama
Alaska
Arizona
Arkansas
California
Delaware
Florida
Georgia
Hawaii
Idaho
Illinois
Indiana
Iowa
Kentucky
Louisiana
Maine
Maryland
Massachusetts
Michigan
Mississippi
Nevada
New Hampshire
New Jersey
New York
North Carolina
Ohio
Oklahoma
Oregon
Pennsylvania
South Carolina
South Dakota
Tennessee
Texas
Virginia
Washington
Wisconsin
Wyoming
Chart by author.
Among these 37 states, you'll find seven that don't have any income tax at all: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. Two more -- New Hampshire and Tennessee -- have only limited state income taxes that apply only to certain types of income.
Yet for the 28 other states listed above, the state governments are making a conscious decision in choosing not to collect income tax on Social Security benefits. The idea is that they hope to keep enough beneficial impacts from retaining retirees within their jurisdictions that it'll offset any lost tax revenue that results from the exemption.
What you'll find elsewhere
Even in the states that aren't on the list above, the news isn't always bad. Only a handful of states follow the federal rules exactly, using the same formula to calculate what gets included as taxable income.
In most of the others, there are ways to get around at least some taxation. Some states offer exemption amounts that let you shelter a certain amount of retirement income from state tax. Others have relatively high income thresholds, and if your total income is below them, you won't have to pay taxes on your benefits.
How to pay as little state tax as you can
There are a few different strategies you can use to try to avoid or minimize state income tax on Social Security benefits:
The most obvious is to live in one of the 37 states that has no taxes on Social Security benefits at all.
If that doesn't work, then look at the available exemptions to see if you can qualify. By taking steps to limit retirement income or other types of income, you can sometimes avoid tax entirely.
If you're likely to owe tax, being smart about financial decisions can minimize your tax burden. For instance, if your state taxes withdrawals from IRAs and 401(k)s, then taking less money out of those accounts could keep your income lower, potentially making more of your benefits eligible for an exemption. At the very least, less taxable income will result in lower state tax bills.
As annoying as it is that the IRS forces some Social Security recipients to pay taxes on their benefits, there are things you can do to lower your tax burden. By knowing which states treat Social Security as tax free, you can breathe easier knowing that at least one potential set of grabby hands won't try to take a cut of your hard-earned monthly Social Security checks.
