In some good news for Minnesota taxpayers who are receiving social security benefits, you may end up paying significantly less in state taxes for the foreseeable future. As of the May 24, 2023 signing of the Minnesota omnibus tax legislation, there have been some significant changes to how Social Security benefits are (or aren’t) taxed that will take effect for the current 2023 tax year.
Prior to the signing of this legislation, a taxpayer could subtract a portion of social security benefits when calculating their Minnesota taxable income. The maximum subtraction as of 2023 was $5,840 for married joint filers (MFJ) and $4,560 for single filers. This subtraction was also reduced for those who had over $88,630 of income for MFJ filers and $69,250 for single filers. This meant that Minnesota taxpayers receiving social security benefits were at most receiving a $5,840 subtraction and many were getting much less benefit.
The Minnesota omnibus tax legislation made significant and meaningful changes to how social security benefits will be taxed by the state starting as of the current tax year (2023). The new rule created a simplified method to calculate the subtraction that allows up to the full (yes- the full!) amount of a taxpayer’s social security benefits as a subtraction. If a taxpayer’s adjusted gross income (AGI) is below $100,000 for MFJ and $78,000 for single filers, then the entire social security benefit is subtracted from income. The subtraction phases out by 10% for each $4,000 of AGI over these thresholds. Taxpayers can use the alternative method (prior law) to calculate the subtraction amounts, if doing so results in a larger subtraction than the simplified method.
Let’s consider an example: Bill and Bonnie Smith are each currently claiming their own social security benefits. Bonnie’s benefit is $30,000 and Bill’s is $20,000 for a total of $50,000 in benefits. If their AGI is below $100,000, then they will take a $50,000 subtraction on their Minnesota income. Typically, this might reduce their MN state taxes around $3,400 as compared to $400 under the alternative method- a welcome $3,000 in additional tax savings! If the Smith’s AGI falls between $140,000 and $100,000, then they will receive a partial subtraction of their social security benefit as they are in the phase out range.
For those taxpayers who are claiming some level of social security benefits, it is now even more beneficial to consider other taxable income sources and whether they can be reduced to stay below the $100k AGI for MFJ ($78k for single filers) threshold. One common planning strategy if the taxpayers are below the required minimum distribution (RMD) age, which is now 73, is to keep any distributions from pre-tax IRAs or Roth conversion activity to a level that will not lose the full social security subtraction. This works well if taxpayers have other sources of funding besides the IRA to help supplement income- such as a taxable brokerage account or savings account. If you are currently preparing for your upcoming retirement, you can consider what types of investment assets you own and whether it might make sense to add additional funds to a taxable brokerage or savings account. Working with a financial planner can help you to maximize these strategies and make a plan that will save on taxes in retirement.
Liz Alf is the Principal of Clerestory Advisors and fee-only CERTIFIED FINANCIAL PLANNERTM located in Minneapolis, MN. She is a member of the National Association of Personal Financial Advisors (NAPFA) the Fee Only Network and Wealthtender. She enjoys serving clients with on-going financial planning and investment management services.