If this is the Icelandic equivalent of US Social Security, and if there is a tax treaty between the US and Iceland, then you may have the option of either,
1. paying tax to Iceland as if this was Icelandic social security, and not paying tax in the US, or
2. ignoring Iceland and paying tax on the US as if it was income from a private trust (that means as ordinary income, at 12%, 22%, 24%, or higher, depending on your income and tax bracket). It is likely also taxable in your state, too, since states don't usually have tax treaties with foreign governments.
But I want to wait for the real expert on foreign tax issues to comment, I left him or her a note.
