Is Social Security Considered Earned Income?

Social Security benefits are not considered earned income by the Internal Revenue Service (IRS). This classification has direct consequences for retirees, particularly concerning their ability to contribute to retirement accounts and how their income is treated for tax purposes. While the payments result from a lifetime of work, they do not meet the specific definition of earned income for the year in which they are received.

Defining Earned Income

The IRS defines earned income as all taxable income and wages received from working for an employer, being self-employed, or owning a business or farm. Common examples are wages, salaries, tips, commissions, and bonuses, which are reported on a Form W-2.

For individuals who are self-employed, earned income is the net earnings from their trade or business after deducting allowable business expenses. This category also includes payments from union strike benefits and certain long-term disability benefits received before an individual reaches the minimum retirement age. The defining characteristic of this income type is that it is a direct result of personal effort. Income sources such as interest, dividends, capital gains, pension payments, and Social Security benefits are categorized as unearned income.

The Classification of Social Security Benefits

Social Security payments are classified as social insurance benefits, a form of government transfer payment, rather than as compensation for services performed in the current year. The benefits are not paid by an employer in exchange for ongoing work. Instead, they are calculated based on a worker’s earnings history and the Social Security taxes they paid throughout their career.

The system is designed to provide a continuous income stream in retirement, or in cases of disability or survivorship, based on prior contributions. This mechanism distinguishes the benefits from earned income, which is paid directly for labor performed in the present.

Implications for Retirement Account Contributions

To contribute to either a Traditional or Roth Individual Retirement Arrangement (IRA), an individual must have taxable compensation, which is synonymous with earned income. This requirement means that a person whose sole source of income is Social Security benefits is ineligible to make contributions to an IRA.

Consider a retiree who receives $25,000 annually from Social Security and has no other income source. This individual cannot contribute to an IRA for the year. In contrast, if that same retiree also works a part-time job earning $10,000 in wages, they would be permitted to contribute to an IRA. The contribution amount would be limited to their earned income, up to the annual maximum set by the IRS.

Tax Treatment of Social Security Benefits

While Social Security is not earned income, a portion of the benefits may be taxable, depending on a recipient’s total income. The IRS uses a calculation based on “combined income” to determine taxability. The formula for combined income is: Adjusted Gross Income (AGI) + Nontaxable Interest + one-half of your Social Security benefits. The total benefits received are reported annually on Form SSA-1099.

For an individual filing singly, if their combined income is between $25,000 and $34,000, up to 50% of their Social Security benefits may be subject to federal income tax. If their combined income exceeds $34,000, up to 85% of their benefits could be taxable. For married couples filing a joint return, up to 50% of benefits may be taxed if their combined income is between $32,000 and $44,000. Up to 85% may be taxed for income above $44,000.

Retirees with other sources of income, such as withdrawals from a 401(k) or IRA, pensions, or part-time work, are more likely to pay taxes on their Social Security benefits. Conversely, individuals who rely almost exclusively on Social Security may find that their benefits are not subject to federal income tax. Some recipients may choose to have federal taxes withheld from their monthly payments by submitting Form W-4V to the Social Security Administration.