7 States With No Income Tax
The Tax Bite in States Without an Income Tax—Are You Really Better Off?
The Internal Revenue Service isn't the only tax entity holding its hand out for a piece of your paycheck. Most states—41 in all—impose a broad-based individual income tax. Only seven lack an income tax altogether: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
Tennessee and New Hampshire fall into a gray area. They tax dividend and interest income, but not earned income.
Why Do States Not Have Income Tax?
State income tax is set at the state level, so it's entirely up to state lawmakers to decide how much to take out of residents' paychecks. Their reasons for nixing income taxes could be driven by their ideals for tax policy, as an incentive to attract new residents, or due to an increase in revenue from another source.
In Alaska, for example, the state income tax was repealed after an oil boom in the '70s. The overwhelming majority of Alaska's revenue now comes from oil industry activity in the state. Alaska decided as a state that it could receive most of the revenue they needed from the oil industry, so they no longer needed to tax residents' incomes.
Tennessee and New Hampshire Income Tax
Tennessee is gradually reducing its "Hall tax" on interest and dividend income. The state's 6% Hall tax rate is being reduced by 1% increments each year until the tax is eliminated in 2021. For the tax year 2020, the rate is 1%.
Alaska is the only other state to ever take legislative steps to eliminate an existing income tax.
New Hampshire—the other state that doesn't tax earned income—assesses a 5% tax on interest and dividend income beyond $2,400. For married couples filing jointly, interest and dividend income isn't taxed until it is in excess of $4,800. An additional $1,200 exemption may be available for certain taxpayers who are disabled, blind, or over the age of 65.
What Happens When You Earn Income in Other States?
If you live in a state that does levy an income tax and you earn income in one of the tax-free states, you must still report that income on your home state tax return. It works both ways—if you live in a tax-free state and earn income in a state that does tax earnings, you must file a non-resident return in that state, even though you don't live there.
Taxes on Retirement Income
Although 43 states impose some version of an income tax, 36 of them, as well as the District of Columbia, take it easy on retirees. Many seniors in those states do not pay income tax, at least if they stop working. Some of these states exclude all retirement income while others exempt only a portion.
Alabama, Arizona, Arkansas, California, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia, Wisconsin, and the District of Columbia do not tax Social Security income. Other states have either partial exemptions or full exemptions for people who meet income requirements. Kansas, for example, exempts Social Security income if your adjusted gross income from all sources is $75,000 or less.
Alabama, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Mississippi, New Hampshire, New York, Pennsylvania, and Tennessee do not tax government pensions, although some reserve this perk for pensions earned in their own state. You might have to pay income tax if you earned a government pension elsewhere then moved to one of these states when you retired.
Pennsylvania also exempts private-sector pension income, and Alabama does not tax income from defined benefit retirement plans. Hawaii does not tax income from contributory retirement plans.
Other Taxes in These States
Before you plant a "For Sale" sign on your lawn and begin packing your bags to move to one of these tax-free states, keep in mind that they still need to raise revenue to function and they have to get that money from somewhere.
States without an income tax often make up for the lack of these revenues in other ways, such as through higher property taxes, sales taxes, fuel taxes, and other taxes. These can add up so you're paying more in overall taxation than you might in a state that does tax your income at a reasonable rate.
New Hampshire and Texas have some of the highest average property taxes per capita in the nation, although New Hampshire does not have a sales tax. Tennessee has one of the highest sales tax rates in the U.S. Washington will get you at the gas pump with a combined federal and state gas tax of nearly $0.68 per gallon.
A Tennessee Example
As an example, consider a person living in Nashville, Tennessee. If you earn $800 a week from your job, you won't pay income tax on that money. However, if you spend $600 of that paycheck every week, you can expect to pay a 9.25% sales tax on everything you buy. That means you spend a total of $55.50 on taxes every week. In other words, you could swap out the sales tax with a 6.93% income tax, and your total tax burden would remain the same. This is a simplified example, and in the real world, your sales tax would likely be higher to account for extra taxes on food items, alcoholic beverages, etc.
States in the northeast and along the west coast also have higher-than-average costs of living that should be taken into account.
It used to be that you could claim a tax deduction for state income taxes you paid if you itemized on your federal return. You can still do that...sort of.
The Tax Cuts and Jobs Act, signed into law in December 2017, caps this deduction at $10,000—and this $10,000 limit includes property taxes as well. Those who don't have to pay income tax might be able to deduct most or all of their property taxes.
The Bottom Line
If your goal is to lower your overall tax burden, you need to understand exactly how you're getting taxed. Otherwise, you could end up trading a high income tax for an even higher sales tax. By reviewing the specific taxes a state imposes, you can have a better idea of whether moving to a different state will truly reduce your taxes. Also, consider any local taxes imposed at the county level.
Spending habits and lifestyles vary dramatically, and so too do the taxes families face. If you don't plan on owning a house, for example, you might not have to worry about higher property taxes.
You must understand all the quirks to the local tax law before you can truly compare your potential tax burden in different states.
The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax or legal advice, please consult with an accountant or an attorney.
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