Taxing Social Security

Several of my constituents have asked how I stand on the taxing of Social Security benefits. Vermont is one of 13 states that tax Social Security benefits. When first asked about this my reaction was that I did not know enough about it to formulate an opinion. I have since done some research on this issue. This page presents the results of my research.

Much of this information comes from an October 2016 paper by Vermont's Joint Fiscal Office (JFO). That the legislature's non-partisan group that researches issues for the Legislature. You can obtain a copy of the paper here.

Vermont does not simply tax your Social Security benefits as if they were additions to your income. Instead, Vermont's taxes are based on your Federal taxable income. Your federal taxable income only includes a portion of your Social Security income. A lot depends on how much income you have.

So an elderly Vermonter whose sole source of income is Social Security is not having that income taxed by the State of Vermont. A well-off Vermonter, who has considerable income as well as Social Security is paying taxes on a portion of that Social Security income. How much of a portion? That get's messy, but here it is:

How much of your Social Security benefit is taxed?
Calculations of taxable Social Security income begin with determining your federal Adjusted Gross Income (AGI). That is a combination of wages, self-employment income, interest income, dividend income etc. The AGI does not include any Social Security income. Once the AGI is determined, you can determine your Combined Income as follows:

      Combined Income = AGI + tax exempt interest + 1/2 of Social Security income

There are several other components to the Combined Income but that's the bulk of it. See the Form 1040 "Social Security Worksheet" for the details. The percent of your Social Security Income that is subject to taxation is then determined by your Combined Income and your filing status.

Here's a table from that JFO paper that shows the percent of Social Security benefits that is taxed by the Feds and, therefor, also by Vermont.

The paper points out that these income thresholds are not indexed and have not changed since 1984. As income has increased, more and more people are having to pay a greater amount of their taxes for their Social Security benefits. Something is wrong there, but that's a Federal, not State, fix.

That 15% minimum exemption is to avoid double-taxation. Workers pay taxes on their employer's share of Social Security deductions, so they should not pay taxes on it again.

What is the result of all this?
In 2014 about half of the recipients of Social Security in the US paid some taxes on those benefits. There's a nice chart in the JFO paper that shows what percentage of Social Security benefits each income group is paying. Yes, those earning more than $114,140 a year are paying taxes on 85% of their Social Security benefit. But those earning between $34,451 and $45,309 are paying taxes on only $38% of their Social Security income. Here's the chart:
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The other consideration is that if Vermont does not tax Social Security benefits, where will she get the money to replace that which it is currently collecting in this way? Vermont collected about $29.8 million by taxing Social Security benefits in 2013. Sixty-five percent of that came from people in the two right-most columns in the chart above.

My Thoughts
I'm still working on this issue and am not clear how I stand. On the one hand there seems to be something unfair about taxing retirement benefits and I know there are many voters who feel that way. On the other hand it is income, similar to other retirement income like interest or dividend income, so why shouldn't it be taxed? There is also always the question of how the state makes up for the lost revenue if the tax on Social Security benefits is removed. That was about $30 million in FY 2013. I just don't know at this point.