Does K-1 Income Affect Social Security Benefits?

Many individuals receiving Social Security benefits also have income reported on a Schedule K-1. Understanding how K-1 income interacts with Social Security benefits is important for financial planning. This article clarifies the impact of K-1 income on the Social Security earnings test and the taxation of Social Security benefits.

Foundational Concepts: K-1 Income and Social Security

A Schedule K-1 is a tax document used to report income, losses, and deductions from pass-through entities such as partnerships, S corporations, and certain trusts and estates. These entities do not pay income tax at the corporate level; instead, they pass their taxable income or losses directly to their partners, shareholders, or beneficiaries, who then report it on their individual tax returns. Common types of income reported on a K-1 include ordinary business income, interest, dividends, and capital gains.

The Social Security Administration (SSA) applies an earnings test for individuals claiming Social Security benefits before their full retirement age (FRA) who continue to work. This test reduces benefits if earnings exceed specific limits. Only “earned income” is considered, which includes wages and net earnings from self-employment.

The taxation of Social Security benefits is determined by “provisional income.” Provisional income is calculated by adding a taxpayer’s adjusted gross income, tax-exempt interest income, and half of their Social Security benefits. If this calculated amount exceeds certain thresholds, a portion of Social Security benefits may become taxable.

K-1 Income and the Social Security Earnings Test

For the Social Security earnings test, a key distinction is whether K-1 income represents “earned income.” The earnings test applies only to income from work, meaning wages and net earnings from self-employment. Investment income, such as dividends, interest, capital gains, and retirement income, are not counted towards the earnings test.

For partners in a partnership or shareholders in an S corporation, the impact of their K-1 income on the earnings test depends on their “material participation” in the business. Material participation means active involvement in business operations. If a partner or S-corporation shareholder materially participates, their share of the business’s ordinary income, specifically the self-employment income portion reported on their K-1, is considered self-employment earnings and counts towards the earnings test.

Conversely, if a K-1 recipient does not materially participate in the business, their K-1 income is considered passive income. Passive income, such as from limited partnership interests or investments where there is no active involvement, does not count towards the Social Security earnings test. This means passive K-1 income will not reduce Social Security benefits under the earnings test, as it is not classified as earned income.

For individuals receiving benefits before their full retirement age, the Social Security Administration will temporarily withhold $1 in benefits for every $2 earned above a certain annual limit. In the year an individual reaches full retirement age, the limit is higher, and the reduction is $1 for every $3 earned above that limit. Once full retirement age is reached, the earnings test no longer applies, and there is no limit on how much can be earned without impacting Social Security benefits.

K-1 Income and Social Security Benefit Taxation

The taxation of Social Security benefits is determined by “provisional income,” a broader measure than what is used for the earnings test. All types of K-1 income, whether active or passive, contribute to a taxpayer’s provisional income. This includes ordinary business income, interest income, dividend income, and capital gains reported on the K-1.

Provisional income is calculated by taking your adjusted gross income, adding any tax-exempt interest, and then adding 50% of your Social Security benefits. For single filers, if provisional income is between $25,000 and $34,000, up to 50% of Social Security benefits may be taxable. If provisional income exceeds $34,000, up to 85% of benefits may be taxable.

For those filing jointly, if provisional income is between $32,000 and $44,000, up to 50% of Social Security benefits may be taxable. If provisional income exceeds $44,000, up to 85% of benefits may be taxable. Unlike the earnings test, where only earned income from material participation counts, passive K-1 income increases provisional income. This can lead to a higher portion of Social Security benefits being subject to federal income tax. Even if K-1 income does not reduce your Social Security checks due to the earnings test, it can still increase your overall tax liability by making more of your Social Security benefits taxable.