Does Kentucky Tax Social Security Benefits?

Each state maintains its own set of rules for how it treats various sources of income for tax purposes. The tax treatment of pensions, retirement account distributions, and Social Security benefits differs from one state to another. This article will focus specifically on the income tax regulations within Kentucky.

Kentucky’s Rule on Taxing Social Security

Kentucky provides a complete exemption for Social Security and Railroad Retirement benefits from its state income tax. This means any benefits received by a resident are not subject to state tax, regardless of the taxpayer’s total income level. These benefits can be subtracted from a taxpayer’s income calculation when filing their state return.

This state-level treatment contrasts sharply with how the federal government handles Social Security. At the federal level, a portion of your benefits may be taxable depending on your “provisional income,” which includes your modified adjusted gross income plus half of your Social Security benefits. For individual filers, if this income is between $25,000 and $34,000, up to 50% of benefits may be taxed, and if it exceeds $34,000, up to 85% may be taxed. For married couples filing jointly, these thresholds are $32,000 and $44,000, respectively.

The difference is an important one for taxpayers to understand. While some of their Social Security benefits might be included in their taxable income on their federal Form 1040, those same benefits are fully deductible on their Kentucky tax return. This favorable state policy simplifies tax planning for retirees who rely on Social Security as a primary source of income.

Exclusion for Other Retirement Income

Beyond the full exemption for Social Security, Kentucky also provides a tax benefit for other types of retirement income. Taxpayers can exclude a portion of income received from pensions, annuities, and distributions from retirement accounts like 401(k)s and IRAs.

For the tax year, Kentucky allows each taxpayer to exclude up to $31,110 of their combined retirement income from these sources. This amount is applied per person, meaning a married couple where both spouses receive qualifying retirement income could potentially exclude up to $62,220 on a joint return.

Any retirement income exceeding this $31,110 per-person threshold is subject to Kentucky’s flat income tax rate of 4.0%. It is important to note that this exclusion is separate from and in addition to the complete exemption for Social Security benefits.

How to Claim Exclusions on Your Tax Return

To take advantage of these tax benefits, taxpayers must report the exclusions on their Kentucky income tax return. The primary form for this is the Kentucky Form 740, the state’s individual income tax return. The specific adjustments for both Social Security and other retirement income are made on a supplemental form, Schedule M, titled “Modifications to Federal Adjusted Gross Income.”

On Schedule M, taxpayers will list the total amount of their Social Security benefits as a subtraction from their federal adjusted gross income. Similarly, the qualifying pension and retirement income, up to the $31,110 limit, is also entered as a subtraction on this schedule.

Once all modifications are calculated on Schedule M, the total subtraction amount is transferred to the main Form 740, reducing the taxpayer’s Kentucky adjusted gross income. For certain government retirees with service before 1998, a separate form, Schedule P, may be needed if their pension income exceeds the standard exclusion amount.