Social Security: Calculation and History of Taxing Benefits

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



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 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
billion in 2007, or 2.3% of its total income. For Medicare, income from taxation of
benefits totaled $10.6 billion in 2007, or 4.7% 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
by the income taxation of Social Security benefits in 2005.
In the 110th 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
W ithholding .............................................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 thresholds2
(based on filing status).
“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
[ h t t p : / / www.i r s.go v/ pub/ i r s-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.

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.

Table 1. Calculation of Taxable Social Security and Tier I
Railroad Retirement Benefits
Provisional Income (*)Calculation of Taxable Social Security and Tier IRailroad Retirement Benefits
Single Taxpayer
Less than $25,000No taxable Social Security or Tier I Railroad Retirement
benefits
$25,000 less than Lesser of (1) 50% of Social Security and Tier I
$34,000 benefits; or
(2) 50% of provisional income above
$25,000
More than $34,000Lesser 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 $32,000No taxable Social Security or Tier I Railroad Retirement
benefits
$32,000 less thanLesser of (1) 50% of Social Security benefits; or
$44,000 (2) 50% of provisional income above
$32,000
More than $44,000Lesser 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 ].

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
+ 50% of Social Security (assume Social Security benefits are $12,948)$6,474$6,474
= Provisional income $28,474$38,474
Step 2: Compare Provisional Income to 1st Tier Threshold
First tier threshold$25,000$25,000
Calculate Excess over First Tier Threshold
Lesser of
Provisional income minus first tier threshold or
Difference between first and second tier thresholds [$9,000]$3,474$9,000
First tier taxable benefits Equals
Lesser of
50% of Social Security or tier I benefits or
50% of excess over first tier$1,737$4,500
Step 3: Compare Prov. Income To 2nd Tier Threshold
Second tier threshold$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
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$1,737$8,303
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, 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


$ 12, 000
$ 10, 000
$8, 000enefits
B
rity
$6,000l Secu
ocia
le S
$4, 000Taxab
$2, 000
$0
$ 0 $3 ,0 00 $6 ,0 00 $ 9,0 00 12,000 15, 00 0 18, 00 0 ,0 00 ,000 27, 00 0 30, 00 0 33, 00 0 36, 00 0 39, 00 0 42 ,0 00 45 ,0 00 48 ,0 00 51,000 4, 00 0 57 ,0 00 60 ,0 00
$$$$21$24$$$$$$$$$$5$$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.

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 theColorado, Connecticut, Iowa,a Kansas, Minnesota, Missouri,a
federal taxable Social SecurityMontana, Nebraska, New Mexico, North Dakota, Rhode
benefitsIsland, Utah, Vermont, West Virginia,
States excluding SocialAlabama, Arizona, Arkansas, California, Delaware, District of
Security benefits from stateColumbia, Georgia, Hawaii, Idaho, Indiana, Illinois,
personal income taxesKentucky, 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 personalAlaska, Florida, Nevada, New Hampshire, South Dakota,
income taxTennessee, 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.

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
Number of
Level of IncomeNumber of SocialSecurity BeneficiariesBeneficiaries Affectedby TaxationPercentage ofBeneficiaries
(in thousands)(in thousands)Affected by Taxation
Less than $10,0005,95700.0%
$10,000 - $15,0005,20140.1%
$15,000 - $20,0003,688120.3%
$20,000 - $25,0003,347110.3%
$25,000 - $30,0002,917762.6%
$30,000 - $40,0005,2601,47828.1%
$40,000 - $50,0004,4973,16870.4%
$50,000 - $100,0008,9318,57896.0%
Over $100,0003,6323,60799.3%
T o tal 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.

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, 00 0
$ 60, 00 0
$ 50, 00 0
Total Taxable Income
$ 40, 00 0come
e InTaxable SS Benefits
$ 30, 00 0Taxabl
Average Social Security Benefit of $12,948
$20,000Taxable Income with No Taxable Social Security
B e n e fi ts
$ 10, 00 0
$0$- 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
2,004,006,008,000,002,004,006,008,000,002,004,006,008,000,002,004,006,008,000,002,004,006,008,000,002,004,006,008,000,00
$ $ $ $ $1 $1 $1 $1 $1 $2 $2 $2 $2 $2 $3 $3 $3 $3 $3 $4 $4 $4 $4 $4 $5 $5 $5 $5 $5 $6
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.

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


$3 5, 00 0
$3 0, 00 0
$2 5, 00 0
$20,000ome$30,000 in Non-Social Security Income
Inc
ble
$1 5, 00 0Taxa
$1 0, 00 0
$20,000 in Non-Social Security Income
$5, 000
$0
$0 $2 , 0 00 $4, 00 0 $6 , 0 00 $ 8, 00 0 $10 , 0 00 $1 2, 00 0 $ 14 , 0 00 $1 6, 00 0 $ 18 , 0 00 $2 0, 00 0 $22 , 0 00 $2 4, 00 0 $ 26 , 0 00
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.

Table 5. Social Security Benefits and Taxes on Social Security
Benefits by Income Class Under 2005 Law
Social SecurityTaxes on SocialTaxes as a Percent
Level of IncomeBenefitsSecurity Benefitsof Benefits
(in millions)(in millions)
Less than $10,000 $40,403$00.0%
$10,000 - $15,000 $53,769 $10.0%
$15,000 - $20,000 $40,480 $40.0%
$20,000 - $25,000 $36,927 $90.0%
$25,000 - $30,000 $33,009 $170.1%
$30,000 - $40,000 $59,893 $3900.7%
$40,000 - $50,000 $51,717 $1,4122.7%
$50,000 - $100,000 $110,421 $11,50810.4%
Over $100,000 $49,378 $10,76721.8%
Total $475,997 $24,1075.1%
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 both11
funds. 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 railroad13


retirement programs were comparatively smaller, $460 million, in 2007.
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/Annua lReport.pdf].

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 would14
be contrary to the purposes of Social Security.
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 appropriate15
model for tax treatment of Social Security benefits. 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.

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.

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.



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 thDate Introduced

110 Congress(Number of Co-sponsors)


Index Thresholds to AllowH.R. 66777/30/2008 (0)
for Cost -of-Living
Adjustments
Repeal the 85% ThresholdH.R. 2 as amended by theb
Senate1/5/2007 (222)
H.R. 192 1/4/2007 (21)
H.R. 1349 a3/6/2007 (1)
H.R. 21585/3/2007 (28)
Repeal All Taxation ofH.R. 191c1/4/2007 (12)
Social Security BenefitsH.R. 25075/24/2007 (5)
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.



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.

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.21
Social Security benefits subject to U.S. income taxes.
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.