Understanding Social Security Taxation

Episode 326 – There’s been a lot of talk lately about making Social Security income tax-free. This would certainly be a popular move, especially for seniors. But doing so comes at a steep price.

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Hello this is Bill Rainaldi, with another edition of Security Mutual’s SML Planning Minute. In today’s episode, understanding Social Security taxation.

There’s been a lot of talk lately about making Social Security income tax-free. This would certainly be a popular move, especially for seniors. But doing so comes at a steep price.

Many people don’t even realize that Social Security income is considered taxable. In fact, Social Security income is tax-free in 41 of the 50 states.[1] But at the federal level, Social Security is considered taxable income—except with a twist. It’s never 100 percent taxable.

Figuring out how much tax you owe from your Social Security benefit is complicated, perhaps more complicated than it should be. This is the result of decades of government fine-tuning.

The good news is that the maximum amount of Social Security that can be taxable is 85 percent, so it’s a bit tax-advantaged compared to other sources, such as a distribution from your IRA or your 401(k).

Figuring out the exact percentage—and then applying it—requires a series of three byzantine calculations. It can be as low as 0 percent or as high as 85 percent, based on your other income. Note that this is not the tax rate. It is the percentage of the income that the tax rate applies to. The tax rate, of course, goes up as your income increases. The maximum federal income tax rate in 2025 is 37 percent.[2]

Note that the calculations require the use of two “threshold” amounts. For married taxpayers those amounts are $32,000 and $44,000. For a single individual, the threshold amounts are $25,000 and $34,000. There will be at least some tax if you’re above these amounts. These were set back in 1993 and are not indexed for inflation. As a result, over time, more and more people are reaching the 85 percent bracket.[3]

Making Social Security income tax-free would save money for a lot of seniors. And it would certainly simplify the tax code.

But all this comes at a price. Few people realize that taxes paid on Social Security end up going to the Social Security Trust Funds.

Social Security benefits are paid differently from everything else. They come exclusively from two special Trust Funds: one for retirement benefits and one for disability. As of the most recent Trustees’ report, the combined Trust Fund balance was $2.79 trillion, down slightly from $2.83 trillion the previous year.[4]

Without any further action, the Trustees project that the Trust Funds will be depleted in the year 2035. If they run out of money, that would not mean that the government stops paying benefits entirely. The Trustees estimate that without any changes to the law, benefits would be reduced by approximately 17 percent.[5]

How does making Social Security benefits tax-free affect all of this? Not many people understand that when you collect Social Security, the income taxes you pay on that benefit end up going into the Social Security Trust Funds. This amounts to approximately 4 percent of their total income.[6] So the funds would have their overall revenue reduced by approximately 4 percent.

This comes on the heels of the Social Security Fairness Act, passed in early 2025, which increased Social Security benefits for certain state and municipal employees and their spouses. It was estimated by the General Account Office (GAO) at the time of passage that this new law would further erode the Social Security Trust Funds, accelerating the depletion date of the fund by six months.[7] Making Social Security income tax-free would only make the situation worse.

So, by solving one problem (helping seniors by making Social Security tax-free), the government would worsen a much bigger problem (the pending insolvency of the Social Security system). Keep in mind that nothing is official yet. These are still just proposals, albeit with a considerable amount of populist support.

Either way, it remains to be seen what will be done to address the really big problem: Social Security’s funding challenge. But the sooner they act, the better.

[1] Walters, Stefon. “41 states that don’t tax Social Security benefits.” usatoday.com. https://www.usatoday.com/story/money/personalfinance/retirement/2025/02/18/states-that-dont-tax-social-security/78454673007/ (accessed March 17, 2025).

[2] Internal Revenue Service. “IRS releases tax inflation adjustments for tax year 2025.” IRS.gov.
https://www.irs.gov/newsroom/irs-releases-tax-inflation-adjustments-for-tax-year-2025 (accessed March 17, 2025).

[3] Marotta, David John. “Nontaxable Social Security Thresholds Are Not Inflation-Adjusted.” Forbes.com. https://www.forbes.com/sites/davidmarotta/2023/08/07/nontaxable-social-security-thresholds-are-not-inflation-adjusted/ (accessed March 26, 2925).

[4] Social Security Administration. “The 2024 Annual Report of The Board of Trustees of The Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds.” Pages 9 and 17. SSA.gov. https://www.ssa.gov/OACT/TR/2024/tr2024.pdf (accessed March 17, 2025).

[5] Picchi, Aimee. “Social Security projected to cut benefits in 2035 barring a fix.” CBSNews.com.  https://www.cbsnews.com/news/social-security-benefits-cut-2035-trust-fund-trustees-report/ (accessed March 26, 2025).

[6] Social Security Administration. “Financial Data for a Selected Time Period.” SSA.gov. https://www.ssa.gov/OACT/ProgData/allOps.html  (accessed March 17, 2025).

[7]  LaPonsie, Maryalene. “Social Security Fairness Act: What It Is and Will It Affect You.” USNews.com. https://money.usnews.com/money/retirement/articles/social-security-fairness-act-what-it-is-and-will-it-pass (accessed March 17, 2025).

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