What States Do Not Tax Railroad Retirement Benefits?

The taxability of railroad retirement benefits can be a point of confusion, as they are subject to unique rules that differ from typical pension plans. The tax treatment varies between the federal and state level, leading many to question how their retirement income will be affected when they file their annual returns. Understanding these regulations is a step for proper financial planning in retirement.

Federal Tax Treatment of Railroad Retirement Benefits

The federal government’s taxation of railroad retirement benefits is administered under the Railroad Retirement Act and is divided into a two-part system, known as Tier 1 and Tier 2. Each tier is treated differently for federal income tax purposes. Tier 1 benefits are designed to be the equivalent of Social Security benefits.

The Social Security Equivalent Benefit (SSEB) portion of Tier 1 is treated identically to Social Security for federal tax purposes. Whether these benefits are taxable depends on the retiree’s total income, and the calculation is detailed in IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits. Any portion of Tier 1 that is not equivalent to Social Security is treated as a pension.

Tier 2 benefits function more like a traditional private pension or annuity. These payments are based on the employee’s railroad service and are considered a contributory pension for federal tax purposes. This dual system means retirees receive two different tax treatments from a single annuity payment, which is reflected on the annual statements they receive from the Railroad Retirement Board (RRB), Forms RRB-1099 and RRB-1099-R.

States That Do Not Tax Railroad Retirement Benefits

State taxation on these benefits is straightforward because a specific federal law provides a nationwide exemption. For retirees in states with a personal income tax, Section 14 of the Railroad Retirement Act (45 U.S.C. § 231) prohibits any state from taxing railroad retirement annuities. This federal law preempts any state-level tax law, meaning neither Tier 1 nor Tier 2 benefits can be included in a retiree’s taxable income.

The question of state income tax is also moot for those in states with no personal income tax. These states include:

• Alaska
• Florida
• Nevada
• New Hampshire
• South Dakota
• Tennessee
• Texas
• Wyoming

Why Confusion About State Taxation Exists

Despite the clear federal prohibition, confusion and errors regarding the state taxation of railroad retirement benefits persist. The primary reason for this misunderstanding stems from the federal tax code’s treatment of Tier 1 benefits. Because the SSEB portion of Tier 1 is handled like Social Security on a federal return, some tax preparers and even state tax agencies mistakenly assume the same logic applies at the state level.

This error is most common in states that tax Social Security benefits for their residents. A tax professional unfamiliar with the specific provisions of the Railroad Retirement Act might see income categorized similarly to Social Security and incorrectly subject it to state tax.

Retirees who find their railroad retirement benefits have been incorrectly taxed by their state should take action. This typically involves filing an amended state tax return to claim a refund for the taxes paid in error. It is often helpful to include a reference to the federal statute to clarify the basis for the exemption.