5 Things to Know About Social Security Benefits and Taxes

According to the Social Security Administration, as of June 2021, there were a total of nearly 70 million people receiving Social Security benefits. These include individuals receiving retirement benefits because of their age or being a widow(er), divorcee, or dependent, as well as those under age 65 receiving disability benefits. Despite the fact that Social Security benefits have been paid to eligible individuals since 1940, there continues to be confusion about the tax implications. Here are 5 things to know. (Note that the same rules apply to equivalent Railroad Retirement Benefits.)

1.      Benefits are not fully taxable

Social Security benefits may be completely tax free or included in income at 50% or 85%. It depends on your filing status, the amount of benefits, and the amount of your other income, including tax-exempt interest.

However, U.S. citizens who are residents of certain foreign countries are exempt from U.S. tax on their benefits. These countries are: Canada, Egypt, Germany, Ireland, Israel, Italy (if also an Italian citizen), Romania, and the United Kingdom. Different rules apply to nonresident aliens eligible to receive Social Security benefits. But U.S. residents in Canada or Germany who receive comparable benefits from these countries are treated as having received U.S. Social Security benefits (there are treaties covering this rule).

Any lump-sum death benefit paid by the Social Security Administration is always tax free.

2.      Disability benefits are taxed the same as retirement benefits

While eligibility for disability benefits is different from eligibility for retirement benefits, the tax treatment is identical. Thus, disability benefits may be tax free or includible in gross income at 50% or 85%.

 3.      Withholding tax from benefits is voluntary

There is no automatic income tax withholding on Social Security benefits. However, you may choose voluntary withholding by completing Form W-4V, Voluntary Withholding Request. This IRS form is sent to the Social Security Administration, not to the IRS. If this withholding election is made, then withholding is at the rate of 7%, 10%, 12%, or 22%, at the taxpayer’s option.

 4.      Gross benefits are used to figure the taxable portion

The amount of benefits taken into account for income tax purposes is the gross amount of benefits. These are reported in box 3 of Form SSA-1099.

Gross benefits used to figure the taxable portion of Social Security benefits are not reduced by premiums withheld for Medicare taxes.

An individual receiving disability benefits from an employer or an insurance company who also receives a lump-sum Social Security disability payment may be required to repay the employer or insurer. In this case, the Social Security benefits remain taxable to the extent explained earlier, but the individual may be entitled to an itemized deduction for the repayment. If the repayment is more than $3,000, a tax credit may be claimed.

5.      Social Security benefits may be treated differently for state income tax purposes

According to the Tax Foundation, 37 states and the District of Columbia have no state income tax or do not include Social Security benefits in calculating taxable income. This means that individuals in the remaining 13 states need to contend with special rules for determining the portion of benefits that may be taxable. Check with your state tax/revenue/finance department.

Conclusion

Just a note of history from the Social Security Administration: “The first monthly retirement check was issued on January 31, 1940, to Ida May Fuller of Ludlow, Vermont, in the amount of $22.54. Miss Fuller, a legal secretary, retired in November 1939. She started collecting benefits in January 1940 at age 65 and lived to be 100 years old, dying in 1975.”

When you start to collect benefits depends on your age or other status (e.g., disabled, widowed, divorced, dependent). How much you collect and for how long is beyond the scope of this discussion, but just remember that some of the benefits may be taxable. You may learn more about Social Security benefits (as well as equivalent Railroad Retirement benefits) in IRS Publication 915.

Resources: https://www.ssa.gov/policy/docs/quickfacts/stat_snapshot/index.html?qs; https://taxfoundation.org/states-that-tax-social-security-benefits-2021/