Order Code RL32552
Social Security: Calculation and
History of Taxing Benefits
Updated October 21, 2008
Janemarie Mulvey
Specialist in Aging Policy
Domestic Social Policy Division
Christine Scott
Specialist in Social Policy
Domestic Social Policy Division
Taxing Benefits
Christine Scott
Specialist in Social Policy
Janemarie Mulvey
Specialist in Aging Policy
January 15, 2010
Congressional Research Service
7-5700
www.crs.gov
RL32552
CRS Report for Congress
Prepared for Members and Committees of Congress
Social Security: Calculation and History
of Taxing Benefits
Summary
Social Security provides monthly benefits to qualified retirees, disabled workers,
and their
spouses and dependents. Until 1984, Social Security benefits were exempt
from the federal
income tax. In 1983, Congress approved recommendations from the
National Commission on
Social Security Reform (also known as the Greenspan
Commission) to tax Social Security
benefits above a specified income threshold.
Specifically, beginning in 1984, up to 50% of Social
Security and Railroad
Retirement Board (RRB) Tier 1 benefits are taxable for individuals whose
provisional income exceeds $25,000. The threshold is $32,000 for married couples.
Provisional Provisional
income is defined as the total income from all sources recognized for tax
purposes plus certain
otherwise tax-exempt income, including half of Social Security
and RRB Tier 1 benefits. The
proceeds from taxing Social Security and Railroad
Retirement Tier I benefits at the 50% rate are
credited to the Old-Age and Survivors
Insurance (OASI) trust fund, the Disability Insurance (DI)
trust fund, and the
Railroad Retirement system respectively, based on the source of the benefit
taxed.
In 1993, Congress passed a second income threshold for the calculation of
taxable Social Security
and RRB Tier I benefits. This second threshold (often
referred to as Tier 2) taxes up to 85% of
benefits for individuals whose provisional
income exceeds $34,000 and for married couples
whose provisional income exceeds
$44,000. The tax proceeds from the second tier goes to the
Medicare Hospital
Insurance (HI) Trust Fund.
Income from taxation of benefits to the Social Security trust funds totaled $18.6
16.9 billion in 2007, 2008,
or 2.31% of its total income. For Medicare, income from taxation of
benefits totaled $10.611.7 billion in 2007, or 4.7
in 2008, or 5.1% of total HI trust fund income. Because
the income thresholds to determine the
taxation of Social Security benefits are not
indexed for inflation or wage growth, the share of
beneficiaries affected by these
thresholds is expected to increase over time. According to the
Congressional Budget
Office (CBO), 39% of (or 16.9 million) Social Security beneficiaries were affected
affected by the income taxation of Social Security benefits in 2005.
In the 110th111th Congress, legislation has been introduced that would impact the
taxation of Social Security benefits, including H.R. 2, H.R. 191, H.R. 192, H.R.
1349, H.R. 2158, H.R. 2507, H.R. 6677, and S.Con.Res. 21. This report will be
updated as warranted by legislative activity.
Contents
Calculation of Taxable Social Security Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Special Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
State Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Impact of Taxing Social Security Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Impact on the Trust Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
History of Taxing Social Security Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Legislation in the 110th Congress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Appendix: Special Considerations Under Taxation of Benefits . . . . . . . . . . . . . 15
Lump Sum Distributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Repayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Coordination of Workers Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Treatment of Nonresident Aliens . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Withholding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
List of Figures
Figure 1. Taxable Social Security Benefits as Non-Social Security
(and Provisional) Income Increases for a Single Retiree with $12,948
in Annual Social Security Benefits, Tax Year 2008 . . . . . . . . . . . . . . . . . . . 5
Figure 2. Taxable Income for an Average Single Retiree Tax Year 2008 . . . . . . . 8
Figure 3. Taxable Income for a Single Retiree with $20,000 or $30,000
in Non-Social Security Income as Annual Social Security Benefits
Increase, Tax Year 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
List of Tables
Table 1. Calculation of Taxable Social Security and Tier I
Railroad Retirement Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Table 2. Example of Calculation of Social Security Benefits for Average
Social Security Recipient and Different Assumptions about Other Income . 4
Table 3. State Income Taxation of Social Security Benefits, Tax Year 2008 . . . . 6
Table 4. Number and Percentage of Beneficiaries with Taxable
Social Security Benefits by Income Class Under 2005 . . . . . . . . . . . . . . . . . 7
Table 5. Social Security Benefits and Taxes on Social Security Benefits
by Income Class Under 2005 Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Table 6. Legislation Introduced in the 110th Congress Relating to
the Taxation of Social Security Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Social Security: Calculation and History
of Taxing Benefits
The Social Security system provides monthly benefits to qualified retirees,
disabled workers, and their spouses and dependents. Until 1984, Social Security
benefits were exempt from the federal income tax. Then in 1984, Congress enacted
legislation to begin to tax Social Security benefits with a formula for determining
taxable benefits that gradually increased as a person’s income rose above a specified
income threshold. In 1993, a second income threshold was added that increased the
share of benefits that are taxable. These two thresholds are often referred to as Tier
1 and Tier 2.
Calculation of Taxable Social Security Benefits
In general, the Social Security and Tier I Railroad Retirement1 benefits of most
recipients are not subject to the income tax. However, up to 85% of Social Security
and Tier I Railroad Retirement benefits can be included in taxable income for
recipients whose “provisional income” exceeds either of two statutory thresholds
(based on filing status).2
“Provisional income” is total income,3 plus certain otherwise tax-exempt income
(tax-exempt interest), plus the addition (or adding back) of certain income
specifically excluded from federal income taxation (interest on certain U.S. savings
bonds,4 employer-provided adoption benefits, foreign earned income or foreign
housing, and income earned in Puerto Rico or American Samoa by bona fide
1
Tier I railroad retirement benefits are paid to a qualified railroad retiree who has met the
quarterly work requirements for Social Security benefit eligibility. The retiree receives
Social Security benefits based on the work history that qualified the retiree for Social
Security benefits, and Tier I benefits based on both the Social Security and railroad work
histories. The actual Social Security benefits received are subtracted from this calculation
of Tier I benefits to get actual Tier I benefits.
2
For additional information on calculating taxable Social Security benefits, see U.S.
Department of the Treasury, Internal Revenue Service, “Social Security and Equivalent
Railroad Retirement Benefits,” Publication 915, 2006, available online at
[http://www.irs.gov/pub/irs-pdf/p915.pdf].
3
Total income is the total of income from all sources recognized for tax purposes. See
Publication 915 for details on the sources of income included in computing provisional
income.
4
Interest on qualified U.S. savings bonds used to pay certain educational expenses is exempt
from federal income taxation.
CRS-2
residents), and plus one-half (50%) of Social Security and Tier I Railroad Retirement
benefits.
The thresholds below which no Social Security or Tier I benefits are taxable are
$25,000 for taxpayers filing as single, head of household, or qualifying widow(er)
and $32,000 for taxpayers filing a joint return. A taxpayer who is married filing
separately who has lived apart from his or her spouse all tax year has a threshold
amount of $25,000. A taxpayer who is married filing separately who lived with his
or her spouse at any point during the tax year, has a threshold amount of $0.
If provisional income is between the first tier thresholds of $25,000 (single) or
$32,000 (married couple) and the second tier thresholds of $34,000 (single) or
$44,000 (married couple), the amount of Social Security and Tier I benefits subject
to tax is the lesser of (1) one-half (50%) of Social Security and Tier I benefits; or (2)
one-half (50%) of provisional income in excess of the first threshold.
If income is above the second tier threshold, the amount of Social Security and
Tier I Railroad Retirement benefits subject to tax is the lesser of (1) 85% of Social
Security and Tier I benefits; or (2) 85% of provisional income above the second
threshold, plus the smaller of (a) $4,500 (single) or $6,000 (married couple);5 or (b)
one-half (50%) of Social Security and Tier I benefits.
Because the threshold for a married taxpayer filing separately who has lived
with his or her spouse at any time during the tax year is $0, the taxable benefits in
such a case are the lesser of 85% of Social Security and Tier I benefits or 85% of
provisional income. None of the thresholds are indexed for inflation or wage growth.
Table 1 summarizes the thresholds and calculation of taxable Social Security and
Tier I Railroad Retirement benefits.
5
The $4,500 (single) and $6,000 (married couple) amounts are the maximum taxes for the
Tier I calculation, and are equivalent to one-half (50%) of the difference between the first
and second tier thresholds.
CRS-3
Table 1. Calculation of Taxable Social Security and Tier I
Railroad Retirement Benefits
Provisional Income (*)
Calculation of Taxable Social Security and Tier I
Railroad Retirement Benefits
Single Taxpayer
Less than $25,000
No taxable Social Security or Tier I Railroad Retirement
benefits
$25,000 less than
$34,000
Lesser of (1) 50% of Social Security and Tier I
benefits; or
(2) 50% of provisional income above
$25,000
More than $34,000
Lesser of (1) 85% of Social Security and Tier I
benefits; or
(2) 85% of provisional income above
$34,000 plus lesser of
(A) $4,500; or
(B) 50% of Social Security and
Tier I benefits
Married Taxpayer
Less than $32,000
No taxable Social Security or Tier I Railroad Retirement
benefits
$32,000 less than
$44,000
Lesser of (1) 50% of Social Security benefits; or
(2) 50% of provisional income above
$32,000
More than $44,000
Lesser of (1) 85% of Social Security benefits; or
(2) 85% of provisional income above
$44,000 plus lesser of
(A) $6,000; or
(B) 50% of Social Security and
Tier I benefits
Source: Table prepared by the Congressional Research Service (CRS).
Note: Provisional income is total income plus certain income exclusions plus one-half (50%) of
Social Security benefits.
The following two examples in Table 2 illustrate how taxable Security benefits
may be calculated for a single retiree in tax year 2008. The retiree is at least 62 years
of age, and receives $12,948 in annual Social Security benefits — the average in
December 2007 for a retiree.6 The examples include other (non-Social Security)
income of $22,000 or $32,000.
6
The average monthly OASI payment for a retiree in December 2007 was $1,079. This
would be an annual payment amount of $12,948. Information on current monthly benefit
payments is available by accessing beneficiary databases at [http://www.ssa.gov/OACT/
ProgData/icp.html].
CRS-4
Table 2. Example of Calculation of Social Security Benefits for
Average Social Security Recipient and Different Assumptions
about Other Income
John
Mary
Step 1: Calculate Provisional Income
Other income
$22,000
$32,000
$6,474
$6,474
$28,474
$38,474
$25,000
$25,000
$3,474
$9,000
$1,737
$4,500
$34,000
$34,000
Calculate Excess over second tier
•
Provisional income minus second tier threshold
$0
$4,474
Second tier taxable benefits
85% of excess
$0
$3,803
$1,737
$8,303
+ 50% of Social Security (assume Social Security benefits are $12,948)
= Provisional income
Step 2: Compare Provisional Income to 1st Tier Threshold
First tier threshold
Calculate Excess over First Tier Threshold
Lesser of
•
Provisional income minus first tier threshold or
•
Difference between first and second tier thresholds [$9,000]
First tier taxable benefits Equals
Lesser of
•
50% of Social Security or tier I benefits or
•
50% of excess over first tier
nd
Step 3: Compare Prov. Income To 2 Tier Threshold
Second tier threshold
Step 4: Calculate Total Taxable Social Security Benefits
If provisional income is less than $34,000, total taxable benefits equal
first tier taxable benefits.
If provisional income is greater than $34,000, total taxable benefits equal
the lesser of
•
85% of Social Security benefits (=$11,006) or
•
First tier taxable benefits plus second tier taxable benefits
Source: Table prepared by the Congressional Research Service (CRS).
Figure 1 shows taxable Social Security benefits for a single retiree with Social
Security benefits of $12,948 as non-Social Security income (and provisional income)
increases. Shown on the figure is the point at which taxable benefits are calculated
using the Tier 2 formula in which the comparisons in the formula use a ratio of 85%
(rather than the 50% ratio for Tier 1). At this point, each additional dollar of nonSocial Security income results in a larger increase in taxable Social Security benefits
(because of the ratio change from 50% to 85% in the calculations). In Figure 1, the
CRS-5
taxable Social Security benefits reach a maximum of 85% of Social Security benefits
(illustrated by a flattening of the line) when non-Social Security income equals
$34,000 in this example.
Figure 1. Taxable Social Security Benefits as Non-Social Security
(and Provisional) Income Increases for a Single Retiree with $12,948
in Annual Social Security Benefits, Tax Year 2008
$12,000
Taxable Social Security Benefits
$10,000
$8,000
$6,000
$4,000
$2,000
$0
$3
,0
00
$6
,0
00
$9
,0
00
$1
2,
00
0
$1
5,
00
0
$1
8,
00
0
$2
1,0
00
$2
4,
00
0
$2
7,
00
0
$3
0,
00
0
$3
3,
00
0
$3
6,
00
0
$3
9,
00
0
$4
2,
00
0
$4
5,
00
0
$4
8,
00
0
$5
1,
00
0
$5
4,
00
0
$5
7,
00
0
$6
0,
00
0
$0
Non-Social Security Income
Source: Figure prepared by the Congressional Research Service (CRS).
The calculation of taxable Social Security benefits depends on the level of
benefits, the tax filing status, and non-Social Security income. Holding non-Social
Security income constant, as benefits increase, taxable Social Security benefits will
increase. For the same levels of non-Social Security income and Social Security
benefits, a married couple will have lower taxable Social Security benefits than a
single retiree. Consequently, Figure 1 does not reflect other levels of benefits, or the
impact of taxation on a married couple filing a joint tax return.
Special Considerations
There are special considerations in which the application of the taxation of
benefits formula may vary. These include lump sum distributions, repayments,
coordination of workers compensation, treatment of non-residential aliens, and
withholding from wages. Each of these issues is discussed in more detail in the
Appendix to this report.
CRS-6
State Taxation
Although the Railroad Retirement Act prohibits states from taxing railroad
retirement benefits (including any federally taxable Tier I benefits), states may tax
Social Security benefits. In general, state personal income taxes follow federal taxes.
That is, many states use as a beginning point for the state income tax calculations
either federal adjusted gross income, federal taxable income, or federal taxes paid.
All of these beginning points include the federally taxed portion of Social Security
benefits. States with these beginning points for state taxation must then make an
adjustment, or subtraction from income (or taxes), for railroad retirement benefits.
A state may also make an adjustment for all or part or the federally taxed Social
Security benefits. Some states do not begin the calculation of state income taxes with
these federal tax values, but instead begin with a calculation based on income by
source. The state may then include part or all of Social Security benefits7 in the state
calculation of income.
In tax year 2008, 28 of the 41 states (and the District of Columbia) with a
personal income tax, fully excluded Social Security benefits from the state personal
income tax. Fourteen states tax all, or part, of Social Security benefits. Nine states
do not have an income tax or have a tax limited to specific kinds of unearned income.
Table 3 identifies what states fall into each of these categories for tax year 2008.
Table 3. State Income Taxation of Social Security Benefits,
Tax Year 2008
States taxing all or part of the
federal taxable Social Security
benefits
Colorado, Connecticut, Iowa,a Kansas, Minnesota, Missouri,a
Montana, Nebraska, New Mexico, North Dakota, Rhode
Island, Utah, Vermont, West Virginia,
States excluding Social
Security benefits from state
personal income taxes
Alabama, Arizona, Arkansas, California, Delaware, District of
Columbia, Georgia, Hawaii, Idaho, Indiana, Illinois,
Kentucky, Louisiana, Maine, Maryland, Massachusetts,
Michigan, Mississippi, New Jersey, New York, North
Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South
Carolina, Virginia and Wisconsin
States without a state personal
income tax
Alaska, Florida, Nevada, New Hampshire, South Dakota,
Tennessee, Texas, Washington, Wyoming
Source: Minnesota House of Representatives, House Research; available at [http://www.house.leg.
state.mn.us/hrd/issinfo/sstaxes.htm].
a. Iowa will fully exempt benefits in 2014, and Missouri will fully exempt benefits beginning in tax
year 2012.
7
States that chose to tax Social Security benefits, generally tax up to the federally taxed
amount.
CRS-7
Impact of Taxing Social Security Benefits
Because the income thresholds to determine the taxation of Social Security
benefits are not indexed for inflation or wage growth, the share of beneficiaries
affected by these thresholds is increasing over time. According to the Congressional
Budget Office (CBO), 39% of (or 16.9 million) Social Security beneficiaries were
affected by the income taxation of Social Security benefits in 2005. This compares
to 32% of Social Security beneficiaries affected by taxation of benefit in 2000 and
26% in 1998.8
Table 4 shows the CBO estimates of the number of Social Security
beneficiaries, the number of beneficiaries affected by the taxation of Social Security
benefits, and the percent of beneficiaries affected by taxation by level of income
(cash income for the tax unit plus capital gains realizations). As shown in Table 4,
the percentage of Social Security beneficiaries affected increases with the income
level, with more than 90% of beneficiaries with an income of $40,000 or more
affected by the taxation of Social Security benefits.
Table 4. Number and Percentage of Beneficiaries with Taxable
Social Security Benefits by Income Class Under 2005
Level of Income
Less than $10,000
$10,000 - $15,000
$15,000 - $20,000
$20,000 - $25,000
$25,000 - $30,000
$30,000 - $40,000
$40,000 - $50,000
$50,000 - $100,000
Over $100,000
Total
Number of
Beneficiaries Affected
Number of Social
Percentage of
Security Beneficiaries
by Taxation
Beneficiaries
(in thousands)
(in thousands)
Affected by Taxation
5,957
0
0.0%
5,201
4
0.1%
3,688
12
0.3%
3,347
11
0.3%
2,917
76
2.6%
5,260
1,478
28.1%
4,497
3,168
70.4%
8,931
8,578
96.0%
3,632
3,607
99.3%
43,429
16,934
39.0%
Source: Congressional Budget Office simulations based on data from the Statistics of Income and
supplemented by data from the Current Population Survey.
Notes: Income is defined as AGI plus statutory adjustments, tax-exempt interest, and nontaxable
Social Security benefits. Number of Social Security beneficiaries includes beneficiaries under and over
age 65.
As previously noted, because of the thresholds not all Social Security benefits
are taxable. Figure 2 shows how Social Security benefits impact taxable income for
a given level of Social Security benefits ($12, 948) for a single retiree in tax year
8
CBO estimates are reported in the Green Book, Committee on Ways and Means, U.S.
House of Representatives (1998, 2000 and unpublished 2008 editions). Changes from year
to year may also reflect changes to CBO’s methodology and data sources over time.
CRS-8
2008.9 As non-Social Security income increases, more of Social Security benefits
become taxable. This leads to an increase in overall taxable income. Because the
taxation of Social Security benefits is capped at 85% in the second tier, the darkly
shaded area in Figure 2 shows that the amount of Social Security benefits that are
taxed remains constant as non-Social Security income increases beyond the second
threshold.
Figure 2. Taxable Income for an Average Single Retiree
Tax Year 2008
$70,000
$60,000
$50,000
Taxable Income
Total Taxable Income
$40,000
Taxable SS Benefits
$30,000
Average Social Security Benefit
of $12,948
$20,000
Taxable Income with No
Taxable Social Security
Benefits
$10,000
$60,00 0
$58,00 0
$56,00 0
$54,00 0
$52,00 0
$50,00 0
$48,00 0
$46,00 0
$44,000
$42,00 0
$40,000
$38,00 0
$36,00 0
$34,00 0
$32,00 0
$30,00 0
$28,00 0
$26,00 0
$24,00 0
$22,00 0
$20,000
$18,00 0
$16,000
$14,00 0
$12,00 0
$8,000
$10,00 0
$6,000
$4,000
$-
$2,000
$0
Non- Social Security Income
Source: Figure prepared by Congressional Research Service (CRS).
Figure 3 shows how different levels of Social Security benefits affect taxable
income for a single retiree with either $20,000 or $30,000 in non-Social Security
income.10 In Figure 3, the Social Security benefits increase until they reach the
annual maximum benefits for a person receiving benefits at full retirement age (65
years and ten months) in 2008 — $26,220.
9
All tax calculations for this report are estimated by CRS. The taxpayer is assumed to have
used the standard deduction, including the additional amount for the elderly and disabled.
10
Ibid.
CRS-9
Figure 3. Taxable Income for a Single Retiree with $20,000 or $30,000
in Non-Social Security Income as Annual Social Security Benefits
Increase, Tax Year 2008
$35,000
$30,000
Taxable Income
$25,000
$20,000
$30,000 in Non-Social Security Income
$15,000
$10,000
$20,000 in Non-Social Security Income
$5,000
$0
$0
$2,000
$4,000
$6,000
$8,000 $10,000 $12,000 $14,000 $16,000 $18,000 $20,000 $22,000 $24,000 $26,000
Annual Social Security Benefits
Source: Figure prepared by the Congressional Research Service (CRS). Assumes Social
Security benefits increase to $26,220 — the maximum benefit in 2008 for a person retiring in
2008 at full retirement age (65 years and 10 months of age).
Table 5 shows the impact of rising income on the share of benefits that are
taxed for the U.S. taxpayers in 2005. Level of income includes cash income plus
capital gains realizations. As shown in Table 5, as income increases, taxes as a
percent of Social Security benefits rises.
CRS-10
Table 5. Social Security Benefits and Taxes on Social Security
Benefits by Income Class Under 2005 Law
Level of Income
Less than $10,000
$10,000 - $15,000
$15,000 - $20,000
$20,000 - $25,000
$25,000 - $30,000
$30,000 - $40,000
$40,000 - $50,000
$50,000 - $100,000
Over $100,000
Total
Social Security
Benefits
(in millions)
$40,403
$53,769
$40,480
$36,927
$33,009
$59,893
$51,717
$110,421
$49,378
$475,997
Taxes on Social
Security Benefits
(in millions)
$0
$1
$4
$9
$17
$390
$1,412
$11,508
$10,767
$24,107
Taxes as a Percent
of Benefits
0.0%
0.0%
0.0%
0.0%
0.1%
0.7%
2.7%
10.4%
21.8%
5.1%
Source: Congressional Budget Office simulations based on data from the Statistics of Income and
supplemented by data from the Current Population Survey.
Notes: Income is defined as AGI plus statutory adjustments, tax-exempt interest, and nontaxable
Social Security benefits. Number of Social Security beneficiaries includes beneficiaries under and over
age 65.
Impact on the Trust Funds
The proceeds from taxing Social Security and Tier I benefits at the 50% rate are
credited to the Old-Age and Survivors Insurance (OASI) trust fund, the Disability
Insurance (DI) trust fund and the Railroad Retirement system respectively, on the
basis of the source of the benefits taxed. Proceeds from taxing Social Security
benefits and Tier I benefits at the 85% rate are credited to the Hospital Insurance trust
fund (HI) of Medicare. In 2007, the Trustees Report reported income to OASDI of
$18.6 billion from the taxation of benefits, or 2.4% of the combined income for both
funds.11 Income from the taxation of benefits in the HI fund were $10.6 billion, or
4.7% of total HI fund income.12 Income taxes transferred to support railroad
retirement programs were comparatively smaller, $460 million, in 2007.13
11
Social Security Administration, 2008 Annual Report of the Board of Trustees of the
Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, April 10,
2008, available at [http://www.ssa.gov/OACT/TR/TR08/tr08.pdf].
12
Center for Medicare and Medicaid Services, 2008 Annual Report of the Board of Trustees
of the Federal Hospital Insurance Trust and Federal Supplementary Medical Insurance
Trust Funds, April 10, 2008, available at [http://www.cms.hhs.gov/ReportsTrustFunds/
downloads/tr2008.pdf].
13
Railroad Retirement Board, 2008 Annual Report, available at [http://www.rrb.gov/pdf/
opa/AnnualRprt/AnnualReport.pdf].
CRS-11
History of Taxing Social Security Benefits
Until 1984, Social Security benefits were exempt from the federal income tax.
The exclusion was based on rulings made in 1938 and 1941 by the Department of the
Treasury, Bureau of Internal Revenue (the predecessor of the Internal Revenue
Service). The 1941 Bureau ruling on OASDI payments viewed benefits as being for
general welfare and reasoned that subjecting the payments to income taxation would
be contrary to the purposes of Social Security.14
Under these rules, the treatment of Social Security benefits was similar to that
of certain types of government transfer payments (such as Aid to Families with
Dependent Children, Supplemental Security Income, and black lung benefits). This
was in sharp contrast to then-current rules for retirement benefits under private
pension plans, the Federal Civil Service Retirement System (CSRS), and other
government pension systems. Benefits from these other pension plans were fully
taxable, except for the portion of total lifetime benefits (using projected life
expectancy) attributable to the employee’s own contributions to the system (and on
which he or she had already paid income tax).
Currently (and as in 1941), under Social Security the worker’s contribution to
the system is his or her share (one-half (50%)) of the payroll tax, officially known as
the Federal Insurance Contributions Act (FICA) tax. The amount the worker pays
into the Social Security system in FICA taxes is not subtracted to determine income
subject to the federal income tax, and is therefore taxed. The employer’s
contributions to the system are not considered part of the employee’s gross income,
and are deductible from the employer’s business income as a business expense.
Consequently, neither the employee or the employer pays taxes on the employer’s
contribution.
The 1979 Advisory Council on Social Security concluded that the 1941 ruling
was wrong and that the tax treatment of private pensions was a more appropriate
model for tax treatment of Social Security benefits.15 The council estimated that the
most anyone who entered the workforce in 1979 would pay in payroll taxes during
his or her lifetime would equal 17% of the Social Security benefits he or she would
ultimately receive. (This was the most any individual would pay; in the aggregate,
workers would make payroll tax payments amounting to substantially less than 17%
of their ultimate benefits.) Because of the administrative difficulties involved in
determining the taxable amount of each individual benefit, the council recommended
instead that half of everyone’s benefit be taxed. They justified this ratio as a matter
of “rough justice” and noted that it coincided with the portion of the tax (the
employer’s share) on which income taxes had not been paid. This position to tax
Social Security benefits was in contrast to the position of the National Commission
14
U.S. Congress, Senate Committee on Finance, Tax Free Status of Social Security Benefits,
Report to Accompany S.Res. 87, Comm. Rep. No. 97-135, June 15, 1981.
15
U.S. Congress, Select Committee on Aging, Hearings Before the Committee on
Retirement Income And Employment, Oversight on Recommendations of the 1979 Social
Security Advisory Council, Statement of Henry Aaron, Chairman of the Advisory Council
on Social Security, Comm. Pub. No. 96-230, March 11 and 13, 1980, p. 13.
CRS-12
on Social Security, established by Congress in the Social Security Amendments of
1977 (P.L. 95-216). The commission did not, in its 1981 final report, include a
recommendation to tax Social Security benefits.
The National Commission on Social Security Reform (often referred to as the
“Greenspan Commission”), appointed by President Reagan in 1981, recommended
in its 1983 report16 that, beginning in 1984, one-half (50%) of Social Security cash
benefits and Tier I benefits payable under the Railroad Retirement Act be taxable for
individuals whose adjusted gross income, excluding Social Security cash benefits,
exceeded certain thresholds — $20,000 for a single taxpayer, and $25,000 for a
married couple, with the proceeds of such taxation credited to the Social Security
trust funds. The commission did not include any provisions for indexing the
threshold amounts. The commission estimated that 10% of OASDI recipients would
be subject to taxation of benefits. The commission acknowledged that the proposal
had a “notch” problem, in that the extra dollar of income that would put one over the
threshold would have had the effect of subjecting fully one-half (50%) of Social
Security benefits to taxation, but trusted that it would be rectified during the
legislative process.
In enacting the 1983 Social Security Amendments (P.L. 98-21), Congress
adopted the commission’s recommendation to tax Social Security benefits, but with
a formula for determining taxable benefits that gradually increased as a person’s
income rose above the thresholds, up to a maximum of one-half (50%) of benefits.
The formula calculated taxable benefits as the lesser of one-half (50%) of benefits
or one-half (50%) of the excess of the taxpayer’s provisional income over thresholds
of $25,000 (single) and $32,000 (married couple). Provisional income was defined
as total income plus certain tax-exempt income (tax-exempt interest) plus certain
income exclusions plus one-half (50%) of Social Security benefits. At the same time,
the tax credit for the elderly and disabled was expanded to provide additional tax
relief for lower income elderly taxpayers.17
In 1993, the Social Security Administration’s Office of the Actuary estimated
that, if pension tax rules were applied to Social Security, the ratio of total employee
Social Security payroll taxes to expected benefits for current recipients (in 1993)
would be approximately 4% or 5%. The actuarial estimates were that for workers
just entering the workforce,18 the ratio would be, on average, about 7%. Because
Social Security benefits replaced a higher proportion of earnings of workers who
were lower paid and had dependents, and because women had longer life
expectancies, the workers with the highest ratio of taxes to benefits would be single,
16
Social Security Administration, Report of the National Commission on Social Security
Reform, January 1983, pp. 2-10 through 2-11, available at [http://www.ssa.gov/history/
reports/gspan.html].
17
The credit was originally created to provide a benefit to retirees that had taxable
retirement income rather than nontaxable Social Security benefits.
18
The average for all workers entering the work force is for all workers born in 1970
entering the workforce. The estimate for single males assumed the worker entering the work
force in 1993 was 22 years old with steady income until retirement at either age 62 or the
normal retirement age.
CRS-13
highly paid males. The estimated ratio for these workers (highly paid males)entering
the workforce in 1993 was 15%.
Applying the tax rules for private and public pensions presents practical
administrative problems. Determining the proper exclusion would be complex for
several reasons, including calculating the ratio of contributions to benefits for each
individual worker’s account when, unlike private pensions, several people may
receive benefits on the basis of the same worker’s account.
President Clinton proposed (as part of his FY1994 budget proposal) that the
portion of Social Security benefits subject to taxation be increased from 50% to 85%,
effective in tax year 1994. As under then-current law, only Social Security recipients
whose provisional income exceeded the thresholds of $25,000 (single) and $32,000
(married couple) were to pay taxes on their benefits. Also as under then-current law,
the first step was to add one-half (50%), not 85%, of benefits to total income.
Because the thresholds and definition of provisional income did not change, the
measure would only affect recipients already paying taxes on benefits. However, the
ratio used to compute the amount of taxable benefits was increased from 50% to
85%. Taxing no more than 85% of Social Security benefits (the portion not based
on contributions by a recipient, including highly paid males) would ensure that no
one would have a higher percentage of Social Security benefits subject to tax than if
the tax treatment of private and civil service pensions were actually applied.
The proceeds from the increase (from 50% to 85%) were slated to be credited
to the Medicare Hospital Insurance program, which had a less favorable financial
outlook than Social Security at that time. Doing so also avoided possible procedural
obstacles (budget points of order that can be raised regarding changes to the Social
Security program in the budget reconciliation process). This measure was included
in the 1993 Omnibus Budget Reconciliation Act (OBRA), which passed the House
on May 27, 1993.
The Senate version of the bill included a provision to tax Social Security
benefits up to 85% but imposed it only after provisional income exceeded new
thresholds of $32,000 (single) and $40,000 (married couple). When the House and
Senate versions of the budget package were negotiated in conference, the conference
agreement adopted the Senate version of the taxation of Social Security benefits
provision and raised the thresholds to $34,000 (single) and $44,000 (married couple).
President Clinton signed the measure into law (as part of P.L. 103-66) on August 10,
1993.
CRS-14
Legislation in the 110th Congress
Table 6 identifies the legislative proposals introduced in the 110th Congress that
change the taxation of benefits. They fall into three key areas:
!
!
!
repeal all taxation of benefits,
repeal the second threshold taxed at 85%, and
index the thresholds to increase with overall wages or prices.
A key policy question that arises is how to offset the potential revenue shortfall
that arises when the thresholds are eliminated or modified. On the one extreme,
eliminating taxation of benefits altogether would result in an annual revenue shortfall
of about $29 billion to the Social Security and Medicare program. Repealing only
the second threshold would result in an annual revenue shortfall to the Medicare HI
Trust Fund of about $11 billion. Some proposals state that revenue shortfalls would
come out of general revenues, whereas others do not specify how to offset potential
revenue shortfalls.
Table 6. Legislation Introduced in the 110th Congress
Relating to the Taxation of Social Security Benefits
Legislation in the
110th Congress
Date Introduced
(Number of Co-sponsors)
Index Thresholds to Allow
for Cost -of-Living
Adjustments
H.R. 6677
7/30/2008 (0)
Repeal the 85% Threshold
H.R. 2 as amended by the
Senateb
H.R. 192
H.R. 1349
H.R. 2158a
1/5/2007 (222)
1/4/2007 (21)
3/6/2007 (1)
5/3/2007 (28)
H.R. 191
H.R. 2507c
1/4/2007 (12)
5/24/2007 (5)
Repeal All Taxation of
Social Security Benefits
Source: Table prepared by CRS.
a. This proposal would appropriate the resulting revenue shortfall from general fund to HI Trust Fund.
b. This bill includes a Sense of the Senate Resolution that would include a full offset of lost revenues
through elimination of wasteful spending.
c. Trust Funds Held Harmless — There are hereby appropriated (out of any money in the Treasury
not otherwise appropriated) for each fiscal year to each fund under the Social Security Act or
the Railroad Retirement Act of 1974 an amount equal to the reduction in the transfers to such
fund for such fiscal year by reason of the amendments made by this section.
CRS-15
Appendix: Special Considerations
Under Taxation of Benefits
Lump Sum Distributions
A Social Security beneficiary may receive a lump sum distribution of benefits
for one or more prior years.19 In this situation, a beneficiary has the option of
choosing between two methods for calculating the taxable portion of the benefits for
prior years: (1) the taxpayer may include all of the benefits for prior years in
calculating the taxable benefits for the current year; or (2) the taxpayer may recalculate the prior year taxable benefits using prior year income and take the
difference between the recalculated taxable benefits and the taxable benefits reported
in each prior year. In computing the taxable portion of benefits in prior years, the
provisional income for the prior years is adjusted gross income plus tax exempt
interest plus the excluded income (as detailed earlier) plus the addition (or add-back)
of the adjustment for student loan interest, plus one-half (50%) of Social Security
benefits.
Repayments
Sometimes a Social Security beneficiary must repay a prior overpayment of
benefits. In this case, the calculation of taxable Social Security benefits is based on
the net benefits — gross benefits less the repayment. Married taxpayers filing a joint
tax return would use the total of the net Social Security benefits for the tax year
received by each party (taxpayer plus spouse). If however, the repayment results in
negative net Social Security benefits, there are two consequences for taxes: (1) there
are no taxable Social Security benefits; and (2) the taxpayer may take a miscellaneous
deduction20 as part of itemized deductions, or a credit for the negative net Social
Security benefits. If the negative net Social Security benefits are less than $3,000,
the taxpayer must include negative net Social Security benefits in miscellaneous
deductions for computing itemized deductions. If the negative net Social Security
benefits are greater than $3,000, the taxpayer must compute the current year tax
liability two ways: (1) using the negative balance as a miscellaneous deduction for
computing itemized deductions; and (2) re-computing the taxes (without the
overpayment income) for the prior years in which an overpayment was received and
subtracting these amounts from the prior year taxes paid, and then subtracting this
result (the sum of the differences in prior year taxes) from the current year tax
liability. If the tax liability computed using the negative balance as a miscellaneous
deduction is lower, the taxpayer claims the deduction. If the tax liability from recomputing prior years taxes is lower, the taxpayer claims a tax credit equal to the
sum of the prior year tax differences.
19
This is not the lump-sum death benefit which is not subject to the federal income tax. An
individual originally denied benefits, but approved on appeal, may receive a lump sum
amount for the period when benefits were denied (which may be prior years).
20
Miscellaneous itemized deductions are subject to a 2% floor. That is, they are included
in itemized deductions to the extent they exceed 2% of adjusted gross income.
CRS-16
Coordination of Workers Compensation
Under current law, an individual’s Social Security benefits (until the full
retirement age), may be reduced by a portion of the Workers Compensation payments
(payments from some other public disability program) received by the individual.
Any reduction in Social Security benefits due to the receipt of Workers
Compensation is considered to be a Social Security benefit and is used in
determining the amount of Social Security benefits subject to taxation.
Treatment of Nonresident Aliens
Citizenship is not required for receipt of Social Security benefits. Aliens may
receive benefits provided they have engaged in covered employment and otherwise
meet eligibility requirements. In general, 85% of the Social Security benefits for
nonresident aliens is subject to income tax (i.e., none of the thresholds apply).
However, there are a number of exceptions to this general rule on the basis of tax
treaties such that nonresident aliens or U.S. citizens living abroad may not have U.S.
Social Security benefits subject to U.S. income taxes.21
Withholding. In general, withholding for a wage earner is based on the
estimated income taxes for a full year of earnings at the periodic (weekly, bi-weekly,
monthly, etc.) rate. Taxable Social Security benefits, and the associated taxes, are
based on the amount of non-Social Security income earned by a recipient during the
tax year. The Social Security Administration, without knowledge about the amount
of other income received by a beneficiary, is unable to properly determine the amount
of taxes that should be withheld from Social Security benefits. Like other non-wage
earners, Social Security recipients can make quarterly estimated income tax
payments. The Uruguay Round Agreements Act (P.L. 103-465) amended the Internal
Revenue Code (IRC) to allow individuals to request that monies be withheld from
certain federal payments to satisfy their income tax liability (this is commonly
referred to as voluntary tax withholding). An amendment to Section 207 of the Social
Security Act allowed this voluntary tax withholding from Social Security benefits.22
Voluntary tax withholding became effective with payments issued in February 1999.
Aliens residing outside the United States are subject to different tax withholding
rules. Section 871 of the Internal Revenue Code imposes an arbitrary rate of tax
withholding (30%) on almost all of the U.S. income of nonresident aliens, unless a
lower rate is fixed by treaty. Thus, 30% of 85% (or 25.5%) of a nonresident alien’s
Social Security benefits may be withheld for federal income taxes.
21
Internal Revenue Service, Publication 915 provides a lists of the countries whose citizens
(as nonresident aliens) are exempt from U.S. income taxes of Social Security benefits, and
countries where residing U.S. citizens are exempt.
22
Because they are not subject to the federal income tax, Supplemental Security Income
payments, Black Lung payments, Medicare premium refunds, Lump Sum Death Payments,
returned check re-issuances, and benefits due before January 1984, are not subject to
voluntary tax withholding.
Security benefits by indexing the income thresholds, repealing the taxation of benefits at the 85%
level, and repealing all taxation of Social Security benefits. This report will be updated as
warranted by legislative activity.
Congressional Research Service
Social Security: Calculation and History of Taxing Benefits
Contents
Calculation of Taxable Social Security Benefits...........................................................................1
Special Considerations ..........................................................................................................4
State Taxation .......................................................................................................................5
Impact of Taxing Social Security Benefits .............................................................................5
Impact on the Trust Funds .....................................................................................................9
History of Taxing Social Security Benefits ..................................................................................9
Figures
Figure 1. Taxable Social Security Benefits as Non-Social Security (and Provisional)
Income Increases for a Single Retiree with $12,948 in Annual Social Security Benefits,
Tax Year 2008 ..........................................................................................................................4
Figure 2. Taxable Income for an Average Single Retiree..............................................................7
Figure 3. Taxable Income for a Single Retiree with $20,000 or $30,000 in Non-Social
Security Income as Annual Social Security Benefits Increase, Tax Year 2008 ...........................8
Tables
Table 1. Calculation of Taxable Social Security and Tier I Railroad Retirement Benefits.............2
Table 2. Example of Calculation of Social Security Benefits for Average Social Security
Recipient and Different Assumptions about Other Income ........................................................3
Table 3. State Income Taxation of Social Security Benefits, Tax Year 2008..................................5
Table 4. Number and Percentage of Beneficiaries with Taxable Social Security Benefits
by Income Class Under 2005....................................................................................................6
Table 5. Social Security Benefits and Taxes on Social Security Benefits by Income Class
Under 2005 Law ......................................................................................................................8
Appendixes
Appendix. Special Considerations Under Taxation of Benefits................................................... 13
Contacts
Author Contact Information ...................................................................................................... 15
Congressional Research Service
Social Security: Calculation and History of Taxing Benefits
T
he Social Security system provides monthly benefits to qualified retirees, disabled
workers, and their spouses and dependents. Until 1984, Social Security benefits were
exempt from the federal income tax. Then in 1984, Congress enacted legislation to begin
to tax Social Security benefits with a formula for determining taxable benefits that gradually
increased as a person’s income rose above a specified income threshold. In 1993, a second
income threshold was added that increased the share of benefits that are taxable. These two
thresholds are often referred to as Tier 1 and Tier 2.
Calculation of Taxable Social Security Benefits
In general, the Social Security and Tier I Railroad Retirement1 benefits of most recipients are not
subject to the income tax. However, up to 85% of Social Security and Tier I Railroad Retirement
benefits can be included in taxable income for recipients whose “provisional income” exceeds
either of two statutory thresholds (based on filing status).2
“Provisional income” is total income, 3 plus certain otherwise tax-exempt income (tax-exempt
interest), plus the addition (or adding back) of certain income specifically excluded from federal
income taxation (interest on certain U.S. savings bonds,4 employer-provided adoption benefits,
foreign earned income or foreign housing, and income earned in Puerto Rico or American Samoa
by bona fide residents), and plus one-half (50%) of Social Security and Tier I Railroad Retirement
benefits.
The thresholds below which no Social Security or Tier I benefits are taxable are $25,000 for
taxpayers filing as single, head of household, or qualifying widow(er) and $32,000 for taxpayers
filing a joint return. A taxpayer who is married filing separately who has lived apart from his or
her spouse all tax year has a threshold amount of $25,000. A taxpayer who is married filing
separately who lived with his or her spouse at any point during the tax year, has a threshold
amount of $0.
If provisional income is between the first tier thresholds of $25,000 (single) or $32,000 (married
couple) and the second tier thresholds of $34,000 (single) or $44,000 (married couple), the
amount of Social Security and Tier I benefits subject to tax is the lesser of (1) one-half (50%) of
Social Security and Tier I benefits; or (2) one-half (50%) of provisional income in excess of the
first threshold.
1
Tier I railroad retirement benefits are paid to a qualified railroad retiree who has met the quarterly work requirements
for Social Security benefit eligibility. The retiree receives Social Security benefits based on the work history that
qualified the retiree for Social Security benefits, and Tier I benefits based on both the Social Security and railroad work
histories. The actual Social Security benefits received are subtracted from this calculation of Tier I benefits to get actual
Tier I benefits.
2
For additional information on calculating taxable Social Security benefits, see U.S. Department of the Treasury,
Internal Revenue Service, “Social Security and Equivalent Railroad Retirement Benefits,” Publication 915, 2006,
available online at http://www.irs.gov/pub/irs-pdf/p915.pdf.
3
Total income is the total of income from all sources recognized for tax purposes. See Publication 915 for details on
the sources of income included in computing provisional income.
4
Interest on qualified U.S. savings bonds used to pay certain educational expenses is exempt from federal income
taxation.
Congressional Research Service
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Social Security: Calculation and History of Taxing Benefits
If income is above the second tier threshold, the amount of Social Security and Tier I Railroad
Retirement benefits subject to tax is the lesser of (1) 85% of Social Security and Tier I benefits; or
(2) 85% of provisional income above the second threshold, plus the smaller of (a) $4,500 (single)
or $6,000 (married couple);5 or (b) one-half (50%) of Social Security and Tier I benefits.
Because the threshold for a married taxpayer filing separately who has lived with his or her
spouse at any time during the tax year is $0, the taxable benefits in such a case are the lesser of
85% of Social Security and Tier I benefits or 85% of provisional income. None of the thresholds
are indexed for inflation or wage growth. Table 1 summarizes the thresholds and calculation of
taxable Social Security and Tier I Railroad Retirement benefits.
Table 1. Calculation of Taxable Social Security and Tier I Railroad
Retirement Benefits
Provisional Income (*)
Calculation of Taxable Social Security and Tier I Railroad
Retirement Benefits
Single Taxpayer
Less than $25,000
No taxable Social Security or Tier I Railroad Retirement benefits
$25,000 less than $34,000
Lesser of (1) 50% of Social Security and Tier I benefits; or
(2) 50% of provisional income above $25,000
More than $34,000
Lesser of (1) 85% of Social Security and Tier I benefits; or
(2) 85% of provisional income above $34,000 plus lesser of
(A) $4,500; or
(B) 50% of Social Security and Tier I benefits
Married Taxpayer
Less than $32,000
No taxable Social Security or Tier I Railroad Retirement benefits
$32,000 less than $44,000
Lesser of (1) 50% of Social Security benefits; or
(2) 50% of provisional income above $32,000
More than $44,000
Lesser of (1) 85% of Social Security benefits; or
(2) 85% of provisional income above $44,000 plus lesser of
(A) $6,000; or
(B) 50% of Social Security and Tier I benefits
Source: Table prepared by the Congressional Research Service (CRS).
Note: Provisional income is total income plus certain income exclusions plus one-half (50%) of Social Security
benefits.
The following two examples in Table 2 illustrate how taxable Security benefits may be calculated
for a single retiree in tax year 2008. The retiree is at least 62 years of age, and receives $12,948 in
annual Social Security benefits—the average in December 2007 for a retiree. 6 The examples
include other (non-Social Security) income of $22,000 or $32,000.
5
The $4,500 (single) and $6,000 (married couple) amounts are the maximum taxes for the Tier I calculation, and are
equivalent to one-half (50%) of the difference between the first and second tier thresholds.
6
The average monthly OASI payment for a retiree in December 2007 was $1,079. This would be an annual payment
(continued...)
Congressional Research Service
2
Social Security: Calculation and History of Taxing Benefits
Table 2. Example of Calculation of Social Security Benefits for Average Social
Security Recipient and Different Assumptions about Other Income
John
Mary
Other income
$22,000
$32,000
+ 50% of Social Security (assume Social Security benefits are $12,948)
$6,474
$6,474
= Provisional income
$28,474
$38,474
$25,000
$25,000
$3,474
$9,000
$1,737
$4,500
$34,000
$34,000
$0
$4,474
$0
$3,803
$1,737
$8,303
Step 1: Calculate Provisional Income
Step 2: Compare Provisional Income to 1st Tier Threshold
First tier threshold
Calculate Excess over First Tier Threshold
Lesser of
•
Provisional income minus first tier threshold or
•
Difference between first and second tier thresholds [$9,000]
First tier taxable benefits Equals
Lesser of
•
50% of Social Security or tier I benefits or
•
50% of excess over first tier
Step 3: Compare Prov. Income To 2nd Tier Threshold
Second tier threshold
Calculate Excess over second tier
•
Provisional income minus second tier threshold
Second tier taxable benefits
85% of excess
Step 4: Calculate Total Taxable Social Security Benefits
If provisional income is less than $34,000, total taxable benefits equal first tier taxable benefits.
If provisional income is greater than $34,000, total taxable benefits equal the lesser of
•
85% of Social Security benefits (=$11,006) or
•
First tier taxable benefits plus second tier taxable benefits
Source: Table prepared by the Congressional Research Service (CRS).
Figure 1 shows taxable Social Security benefits for a single retiree with Social Security benefits
of $12,948 as non-Social Security income (and provisional income) increases. Shown on the
figure is the point at which taxable benefits are calculated using the Tier 2 formula in which the
comparisons in the formula use a ratio of 85% (rather than the 50% ratio for Tier 1). At this point,
each additional dollar of non-Social Security income results in a larger increase in taxable Social
Security benefits (because of the ratio change from 50% to 85% in the calculations). In Figure 1,
(...continued)
amount of $12,948. Information on current monthly benefit payments is available by accessing beneficiary databases at
http://www.ssa.gov/OACT/ProgData/icp.html.
Congressional Research Service
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Social Security: Calculation and History of Taxing Benefits
the taxable Social Security benefits reach a maximum of 85% of Social Security benefits
(illustrated by a flattening of the line) when non-Social Security income equals $34,000 in this
example.
Figure 1.Taxable Social Security Benefits as Non-Social Security (and Provisional)
Income Increases for a Single Retiree with $12,948 in Annual Social Security
Benefits,Tax Year 2008
Source: Figure prepared by the Congressional Research Service (CRS).
The calculation of taxable Social Security benefits depends on the level of benefits, the tax filing
status, and non-Social Security income. Holding non-Social Security income constant, as benefits
increase, taxable Social Security benefits will increase. For the same levels of non-Social Security
income and Social Security benefits, a married couple will have lower taxable Social Security
benefits than a single retiree. Consequently, Figure 1 does not reflect other levels of benefits, or
the impact of taxation on a married couple filing a joint tax return.
Special Considerations
There are special considerations in which the application of the taxation of benefits formula may
vary. These include lump sum distributions, repayments, coordination of workers compensation,
treatment of non-residential aliens, and withholding from wages. Each of these issues is discussed
in more detail in the Appendix to this report.
Congressional Research Service
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Social Security: Calculation and History of Taxing Benefits
State Taxation
Although the Railroad Retirement Act prohibits states from taxing railroad retirement benefits
(including any federally taxable Tier I benefits), states may tax Social Security benefits. In
general, state personal income taxes follow federal taxes. That is, many states use as a beginning
point for the state income tax calculations either federal adjusted gross income, federal taxable
income, or federal taxes paid. All of these beginning points include the federally taxed portion of
Social Security benefits. States with these beginning points for state taxation must then make an
adjustment, or subtraction from income (or taxes), for railroad retirement benefits. A state may
also make an adjustment for all or part or the federally taxed Social Security benefits. Some states
do not begin the calculation of state income taxes with these federal tax values, but instead begin
with a calculation based on income by source. The state may then include part or all of Social
Security benefits7 in the state calculation of income.
In tax year 2008, 28 of the 41 states (and the District of Columbia) with a personal income tax,
fully excluded Social Security benefits from the state personal income tax. Fourteen states tax all,
or part, of Social Security benefits. Nine states do not have an income tax or have a tax limited to
specific kinds of unearned income. Table 3 identifies what states fall into each of these categories
for tax year 2008.
Table 3. State Income Taxation of Social Security Benefits,Tax Year 2008
States taxing all or part
of the federal taxable
Social Security benefits
Colorado, Connecticut, Iowa,a Kansas, Minnesota, Missouri,a Montana, Nebraska, New
Mexico, North Dakota, Rhode Island, Utah, Vermont, West Virginia
States excluding Social
Security benefits from
state personal income
taxes
Alabama, Arizona, Arkansas, California, Delaware, District of Columbia, Georgia, Hawaii,
Idaho, Indiana, Illinois, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan,
Mississippi, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon,
Pennsylvania, South Carolina, Virginia and Wisconsin
States without a state
personal income tax
Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington,
Wyoming
Source: Minnesota House of Representatives, House Research; available at http://www.house.leg.state.mn.us/
hrd/issinfo/sstaxes.htm.
a.
Iowa will fully exempt benefits in 2014, and Missouri will fully exempt benefits beginning in tax year 2012.
Impact of Taxing Social Security Benefits
Because the income thresholds to determine the taxation of Social Security benefits are not
indexed for inflation or wage growth, the share of beneficiaries affected by these thresholds is
increasing over time. According to the Congressional Budget Office (CBO), 39% of (or 16.9
million) Social Security beneficiaries were affected by the income taxation of Social Security
benefits in 2005. This compares to 32% of Social Security beneficiaries affected by taxation of
benefit in 2000 and 26% in 1998.8
7
States that chose to tax Social Security benefits, generally tax up to the federally taxed amount.
CBO estimates are reported in the Green Book, Committee on Ways and Means, U.S. House of Representatives
(continued...)
8
Congressional Research Service
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Social Security: Calculation and History of Taxing Benefits
Table 4 shows the CBO estimates of the number of Social Security beneficiaries, the number of
beneficiaries affected by the taxation of Social Security benefits, and the percent of beneficiaries
affected by taxation by level of income (cash income for the tax unit plus capital gains
realizations). As shown in Table 4, the percentage of Social Security beneficiaries affected
increases with the income level, with more than 90% of beneficiaries with an income of $40,000
or more affected by the taxation of Social Security benefits.
Table 4. Number and Percentage of Beneficiaries with Taxable Social Security
Benefits by Income Class Under 2005
Level of Income
Number of Social
Security Beneficiaries
(in thousands)
Number of Beneficiaries
Affected by Taxation
(in thousands)
Percentage of Beneficiaries
Affected by Taxation
Less than $10,000
5,957
0
0.0%
$10,000 - $15,000
5,201
4
0.1%
$15,000 - $20,000
3,688
12
0.3%
$20,000 - $25,000
3,347
11
0.3%
$25,000 - $30,000
2,917
76
2.6%
$30,000 - $40,000
5,260
1,478
28.1%
$40,000 - $50,000
4,497
3,168
70.4%
$50,000 $100,000
8,931
8,578
96.0%
Over $100,000
3,632
3,607
99.3%
43,429
16,934
39.0%
Total
Source: Congressional Budget Office simulations based on data from the Statistics of Income and supplemented
by data from the Current Population Survey.
Notes: Income is defined as AGI plus statutory adjustments, tax-exempt interest, and nontaxable Social Security
benefits. Number of Social Security beneficiaries includes beneficiaries under and over age 65.
As previously noted, because of the thresholds not all Social Security benefits are taxable. Figure
2 shows how Social Security benefits impact taxable income for a given level of Social Security
benefits ($12, 948) for a single retiree in tax year 2008.9 As non-Social Security income increases,
more of Social Security benefits become taxable. This leads to an increase in overall taxable
income. Because the taxation of Social Security benefits is capped at 85% in the second tier, the
darkly shaded area in Figure 2 shows that the amount of Social Security benefits that are taxed
remains constant as non-Social Security income increases beyond the second threshold.
(...continued)
(1998, 2000 and 2008 editions). Changes from year to year may also reflect changes to CBO’s methodology and data
sources over time.
9
All tax calculations for this report are estimated by CRS. The taxpayer is assumed to have used the standard
deduction, including the additional amount for the elderly and disabled.
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Social Security: Calculation and History of Taxing Benefits
Figure 2.Taxable Income for an Average Single Retiree
Tax Year 2008
Source: Figure prepared by congressional Research Service (CRS).
Figure 3 shows how different levels of Social Security benefits affect taxable income for a single
retiree with either $20,000 or $30,000 in non-Social Security income.10 In Figure 3, the Social
Security benefits increase until they reach the annual maximum benefits for a person receiving
benefits at full retirement age (65 years and 10 months) in 2008—$26,220.
10
Ibid.
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Figure 3.Taxable Income for a Single Retiree with $20,000 or $30,000 in Non-Social
Security Income as Annual Social Security Benefits Increase,Tax Year 2008
Source: Figure prepared by the Congressional Research Service (CRS). Assumes Social Security benefits
increase to $26,220—the maximum benefit in 2008 for a person retiring in 2008 at full retirement age (65 years
and 10 months of age).
Table 5 shows the impact of rising income on the share of benefits that are taxed for the U.S.
taxpayers in 2005. Level of income includes cash income plus capital gains realizations. As
shown in Table 5, as income increases, taxes as a percent of Social Security benefits rises.
Table 5. Social Security Benefits and Taxes on Social Security Benefits by Income
Class Under 2005 Law
Taxes on Social
Security Benefits
(in millions)
Level of Income
Social Security Benefits
(in millions)
Less than $10,000
$40,403
$0
0.0%
$10,000 - $15,000
$53,769
$1
0.0%
$15,000 - $20,000
$40,480
$4
0.0%
$20,000 - $25,000
$36,927
$9
0.0%
$25,000 - $30,000
$33,009
$17
0.1%
$30,000 - $40,000
$59,893
$390
0.7%
$40,000 - $50,000
$51,717
$1,412
2.7%
$50,000 - $100,000
$110,421
$11,508
10.4%
$49,378
$10,767
21.8%
$475,997
$24,107
5.1%
Over $100,000
Total
Congressional Research Service
Taxes as a Percent
of Benefits
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Social Security: Calculation and History of Taxing Benefits
Source: Congressional Budget Office simulations based on data from the Statistics of Income and supplemented
by data from the Current Population Survey.
Notes: Income is defined as AGI plus statutory adjustments, tax-exempt interest, and nontaxable Social Security
benefits. Number of Social Security beneficiaries includes beneficiaries under and over age 65.
Impact on the Trust Funds
The proceeds from taxing Social Security and Tier I benefits at the 50% rate are credited to the
Old-Age and Survivors Insurance (OASI) trust fund, the Disability Insurance (DI) trust fund and
the Railroad Retirement system respectively, on the basis of the source of the benefits taxed.
Proceeds from taxing Social Security benefits and Tier I benefits at the 85% rate are credited to
the Hospital Insurance trust fund (HI) of Medicare. In 2008, the Trustees Report reported income
to OASDI of $16.9 billion from the taxation of benefits, or 2.1% of the combined income for both
funds.11 Income from the taxation of benefits in the HI fund were $11.7 billion, or 5.1% of total
HI fund income. 12 Income taxes transferred to support railroad retirement programs were
comparatively smaller, $359 million, in 2008.13
History of Taxing Social Security Benefits
Until 1984, Social Security benefits were exempt from the federal income tax. The exclusion was
based on rulings made in 1938 and 1941 by the Department of the Treasury, Bureau of Internal
Revenue (the predecessor of the Internal Revenue Service). The 1941 Bureau ruling on OASDI
payments viewed benefits as being for general welfare and reasoned that subjecting the payments
to income taxation would be contrary to the purposes of Social Security.14
Under these rules, the treatment of Social Security benefits was similar to that of certain types of
government transfer payments (such as Aid to Families with Dependent Children, Supplemental
Security Income, and black lung benefits). This was in sharp contrast to then-current rules for
retirement benefits under private pension plans, the Federal Civil Service Retirement System
(CSRS), and other government pension systems. Benefits from these other pension plans were
fully taxable, except for the portion of total lifetime benefits (using projected life expectancy)
attributable to the employee’s own contributions to the system (and on which he or she had
already paid income tax).
Currently (and as in 1941), under Social Security the worker’s contribution to the system is his or
her share (one-half (50%)) of the payroll tax, officially known as the Federal Insurance
Contributions Act (FICA) tax. The amount the worker pays into the Social Security system in
11
Social Security Administration, 2009 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors
Insurance and Disability Insurance Trust Funds, May 12, 2009, available at http://www.ssa.gov/OACT/TR/TR09/
tr09.pdf.
12
Center for Medicare and Medicaid Services, 2009 Annual Report of the Board of Trustees of the Federal Hospital
Insurance Trust and Federal Supplementary Medical Insurance Trust Funds, May 12, 2009, available at
http://www.cms.hhs.gov/ReportsTrustFunds/downloads/tr2009.pdf.
13
Railroad Retirement Board, 2008 Annual Report, available at http://www.rrb.gov/pdf/opa/annualrprt/
annualreport.pdf.
14
U.S. Congress, Senate Committee on Finance, Tax Free Status of Social Security Benefits, Report to Accompany
S.Res. 87, Comm. Rep. No. 97-135, June 15, 1981.
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FICA taxes is not subtracted to determine income subject to the federal income tax, and is
therefore taxed. The employer’s contributions to the system are not considered part of the
employee’s gross income, and are deductible from the employer’s business income as a business
expense. Consequently, neither the employee or the employer pays taxes on the employer’s
contribution.
The 1979 Advisory Council on Social Security concluded that the 1941 ruling was wrong and that
the tax treatment of private pensions was a more appropriate model for tax treatment of Social
Security benefits.15 The council estimated that the most anyone who entered the workforce in
1979 would pay in payroll taxes during his or her lifetime would equal 17% of the Social Security
benefits he or she would ultimately receive. (This was the most any individual would pay; in the
aggregate, workers would make payroll tax payments amounting to substantially less than 17% of
their ultimate benefits.) Because of the administrative difficulties involved in determining the
taxable amount of each individual benefit, the council recommended instead that half of
everyone’s benefit be taxed. They justified this ratio as a matter of “rough justice” and noted that
it coincided with the portion of the tax (the employer’s share) on which income taxes had not
been paid. This position to tax Social Security benefits was in contrast to the position of the
National Commission on Social Security, established by Congress in the Social Security
Amendments of 1977 (P.L. 95-216). The commission did not, in its 1981 final report, include a
recommendation to tax Social Security benefits.
The National Commission on Social Security Reform (often referred to as the “Greenspan
Commission”), appointed by President Reagan in 1981, recommended in its 1983 report16 that,
beginning in 1984, one-half (50%) of Social Security cash benefits and Tier I benefits payable
under the Railroad Retirement Act be taxable for individuals whose adjusted gross income,
excluding Social Security cash benefits, exceeded certain thresholds—$20,000 for a single
taxpayer, and $25,000 for a married couple, with the proceeds of such taxation credited to the
Social Security trust funds. The commission did not include any provisions for indexing the
threshold amounts. The commission estimated that 10% of OASDI recipients would be subject to
taxation of benefits. The commission acknowledged that the proposal had a “notch” problem, in
that the extra dollar of income that would put one over the threshold would have had the effect of
subjecting fully one-half (50%) of Social Security benefits to taxation, but trusted that it would be
rectified during the legislative process.
In enacting the 1983 Social Security Amendments (P.L. 98-21), Congress adopted the
commission’s recommendation to tax Social Security benefits, but with a formula for determining
taxable benefits that gradually increased as a person’s income rose above the thresholds, up to a
maximum of one-half (50%) of benefits. The formula calculated taxable benefits as the lesser of
one-half (50%) of benefits or one-half (50%) of the excess of the taxpayer’s provisional income
over thresholds of $25,000 (single) and $32,000 (married couple). Provisional income was
defined as total income plus certain tax-exempt income (tax-exempt interest) plus certain income
exclusions plus one-half (50%) of Social Security benefits. At the same time, the tax credit for the
15
U.S. Congress, Select Committee on Aging, Hearings Before the Committee on Retirement Income And Employment,
Oversight on Recommendations of the 1979 Social Security Advisory Council, Statement of Henry Aaron, Chairman of
the Advisory Council on Social Security, Comm. Pub. No. 96-230, March 11 and 13, 1980, p. 13.
16
Social Security Administration, Report of the National Commission on Social Security Reform, January 1983, pp. 210 through 2-11, available at http://www.ssa.gov/history/reports/gspan.html.
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elderly and disabled was expanded to provide additional tax relief for lower income elderly
taxpayers.17
In 1993, the Social Security Administration’s Office of the Actuary estimated that, if pension tax
rules were applied to Social Security, the ratio of total employee Social Security payroll taxes to
expected benefits for current recipients (in 1993) would be approximately 4% or 5%. The
actuarial estimates were that for workers just entering the workforce,18 the ratio would be, on
average, about 7%. Because Social Security benefits replaced a higher proportion of earnings of
workers who were lower paid and had dependents, and because women had longer life
expectancies, the workers with the highest ratio of taxes to benefits would be single, highly paid
males. The estimated ratio for these workers (highly paid males)entering the workforce in 1993
was 15%.
Applying the tax rules for private and public pensions presents practical administrative problems.
Determining the proper exclusion would be complex for several reasons, including calculating the
ratio of contributions to benefits for each individual worker’s account when, unlike private
pensions, several people may receive benefits on the basis of the same worker’s account.
President Clinton proposed (as part of his FY1994 budget proposal) that the portion of Social
Security benefits subject to taxation be increased from 50% to 85%, effective in tax year 1994. As
under then-current law, only Social Security recipients whose provisional income exceeded the
thresholds of $25,000 (single) and $32,000 (married couple) were to pay taxes on their benefits.
Also as under then-current law, the first step was to add one-half (50%), not 85%, of benefits to
total income. Because the thresholds and definition of provisional income did not change, the
measure would only affect recipients already paying taxes on benefits. However, the ratio used to
compute the amount of taxable benefits was increased from 50% to 85%. Taxing no more than
85% of Social Security benefits (the portion not based on contributions by a recipient, including
highly paid males) would ensure that no one would have a higher percentage of Social Security
benefits subject to tax than if the tax treatment of private and civil service pensions were actually
applied.
The proceeds from the increase (from 50% to 85%) were slated to be credited to the Medicare
Hospital Insurance program, which had a less favorable financial outlook than Social Security at
that time. Doing so also avoided possible procedural obstacles (budget points of order that can be
raised regarding changes to the Social Security program in the budget reconciliation process).
This measure was included in the 1993 Omnibus Budget Reconciliation Act (OBRA), which
passed the House on May 27, 1993.
The Senate version of the bill included a provision to tax Social Security benefits up to 85% but
imposed it only after provisional income exceeded new thresholds of $32,000 (single) and
$40,000 (married couple). When the House and Senate versions of the budget package were
negotiated in conference, the conference agreement adopted the Senate version of the taxation of
Social Security benefits provision and raised the thresholds to $34,000 (single) and $44,000
17
The credit was originally created to provide a benefit to retirees that had taxable retirement income rather than
nontaxable Social Security benefits.
18
The average for all workers entering the work force is for all workers born in 1970 entering the workforce. The
estimate for single males assumed the worker entering the work force in 1993 was 22 years old with steady income
until retirement at either age 62 or the normal retirement age.
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Social Security: Calculation and History of Taxing Benefits
(married couple). President Clinton signed the measure into law (as part of P.L. 103-66) on
August 10, 1993.
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Appendix. Special Considerations Under Taxation
of Benefits
Lump Sum Distributions
A Social Security beneficiary may receive a lump sum distribution of benefits for one or more
prior years.19 In this situation, a beneficiary has the option of choosing between two methods for
calculating the taxable portion of the benefits for prior years: (1) the taxpayer may include all of
the benefits for prior years in calculating the taxable benefits for the current year; or (2) the
taxpayer may re-calculate the prior year taxable benefits using prior year income and take the
difference between the recalculated taxable benefits and the taxable benefits reported in each
prior year. In computing the taxable portion of benefits in prior years, the provisional income for
the prior years is adjusted gross income plus tax exempt interest plus the excluded income (as
detailed earlier) plus the addition (or add-back) of the adjustment for student loan interest, plus
one-half (50%) of Social Security benefits.
Repayments
Sometimes a Social Security beneficiary must repay a prior overpayment of benefits. In this case,
the calculation of taxable Social Security benefits is based on the net benefits—gross benefits less
the repayment. Married taxpayers filing a joint tax return would use the total of the net Social
Security benefits for the tax year received by each party (taxpayer plus spouse). If however, the
repayment results in negative net Social Security benefits, there are two consequences for taxes:
(1) there are no taxable Social Security benefits; and (2) the taxpayer may take a miscellaneous
deduction20 as part of itemized deductions, or a credit for the negative net Social Security
benefits. If the negative net Social Security benefits are less than $3,000, the taxpayer must
include negative net Social Security benefits in miscellaneous deductions for computing itemized
deductions. If the negative net Social Security benefits are greater than $3,000, the taxpayer must
compute the current year tax liability two ways: (1) using the negative balance as a miscellaneous
deduction for computing itemized deductions; and (2) re-computing the taxes (without the
overpayment income) for the prior years in which an overpayment was received and subtracting
these amounts from the prior year taxes paid, and then subtracting this result (the sum of the
differences in prior year taxes) from the current year tax liability. If the tax liability computed
using the negative balance as a miscellaneous deduction is lower, the taxpayer claims the
deduction. If the tax liability from re-computing prior years taxes is lower, the taxpayer claims a
tax credit equal to the sum of the prior year tax differences.
19
This is not the lump-sum death benefit which is not subject to the federal income tax. An individual originally denied
benefits, but approved on appeal, may receive a lump sum amount for the period when benefits were denied (which
may be prior years).
20
Miscellaneous itemized deductions are subject to a 2% floor. That is, they are included in itemized deductions to the
extent they exceed 2% of adjusted gross income.
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Coordination of Workers Compensation
Under current law, an individual’s Social Security benefits (until the full retirement age), may be
reduced by a portion of the Workers Compensation payments (payments from some other public
disability program) received by the individual. Any reduction in Social Security benefits due to
the receipt of Workers Compensation is considered to be a Social Security benefit and is used in
determining the amount of Social Security benefits subject to taxation.
Treatment of Nonresident Aliens
Citizenship is not required for receipt of Social Security benefits. Aliens may receive benefits
provided they have engaged in covered employment and otherwise meet eligibility requirements.
In general, 85% of the Social Security benefits for nonresident aliens is subject to income tax
(i.e., none of the thresholds apply). However, there are a number of exceptions to this general rule
on the basis of tax treaties such that nonresident aliens or U.S. citizens living abroad may not
have U.S. Social Security benefits subject to U.S. income taxes.21
Withholding
In general, withholding for a wage earner is based on the estimated income taxes for a full year of
earnings at the periodic (weekly, bi-weekly, monthly, etc.) rate. Taxable Social Security benefits,
and the associated taxes, are based on the amount of non-Social Security income earned by a
recipient during the tax year. The Social Security Administration, without knowledge about the
amount of other income received by a beneficiary, is unable to properly determine the amount of
taxes that should be withheld from Social Security benefits. Like other non-wage earners, Social
Security recipients can make quarterly estimated income tax payments. The Uruguay Round
Agreements Act (P.L. 103-465) amended the Internal Revenue Code (IRC) to allow individuals to
request that monies be withheld from certain federal payments to satisfy their income tax liability
(this is commonly referred to as voluntary tax withholding). An amendment to Section 207 of the
Social Security Act allowed this voluntary tax withholding from Social Security benefits.22
Voluntary tax withholding became effective with payments issued in February 1999.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16) permitted
voluntary withholding from Social Security benefits at rates of 7%, and equal to the bottom three
tax bracket tax rates (currently 10%, 15%, and 25%). This P.L. 107-16 change will expire on
December 31, 2010.
Aliens residing outside the United States are subject to different tax withholding rules. Section
871 of the Internal Revenue Code imposes an arbitrary rate of tax withholding (30%) on almost
all of the U.S. income of nonresident aliens, unless a lower rate is fixed by treaty. Thus, 30% of
85% (or 25.5%) of a nonresident alien’s Social Security benefits may be withheld for federal
income taxes.
21
Internal Revenue Service, Publication 915 provides a lists of the countries whose citizens (as nonresident aliens) are
exempt from U.S. income taxes of Social Security benefits, and countries where residing U.S. citizens are exempt.
22
Because they are not subject to the federal income tax, Supplemental Security Income payments, Black Lung
payments, Medicare premium refunds, Lump Sum Death Payments, returned check re-issuances, and benefits due
before January 1984, are not subject to voluntary tax withholding.
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Author Contact Information
Christine Scott
Specialist in Social Policy
cscott@crs.loc.gov, 7-7366
Congressional Research Service
Janemarie Mulvey
Specialist in Aging Policy
jmulvey@crs.loc.gov, 7-6928
15