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 that's holding its hand out for a piece of your paycheck. Most states—41 in all—impose a broad-based individual income tax. Only seven states 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.
The state income tax was repealed after an oil boom in the '70s in Alaska. The overwhelming majority of Alaska's revenue comes from oil industry activity in the state. Alaska decided that it could receive most of the revenue it needed from the oil industry, so the state 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 has been reduced by 1% increments each year until the tax will be eliminated beginning January 1, 2021. The Hall tax rate is just 1% in tax year 2020.
Alaska is the only other state to ever take legislative steps to eliminate an existing income tax.
New Hampshire assesses a 5% tax on interest and dividend income beyond $2,400 as of 2020. Interest and dividend income aren't taxed for married couples filing joint returns until it exceeds $4,800. An additional $1,200 exemption is available for certain taxpayers who are disabled, blind, or over the age of 65.
What If You Earn Income in Other States?
You must still report income earned in other states on your home state tax return if you live in a state that does levy an income tax, even if that income is earned in one of the tax-free states. 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
Forty-three states impose some version of an income tax, but 36 of them and the District of Columbia take it easy on retirees. Many seniors in these states don't pay income tax, at least when 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 don't tax Social Security income.
Other states have either partial exemptions or full exemptions for people who meet certain income requirements. For example, Kansas 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 don't 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 you moved to one of these states when you retired.
Pennsylvania also exempts private-sector pension income, and Alabama doesn't tax income from defined benefit retirement plans. Hawaii doesn't 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 have 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 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 have 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 doesn't 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.
States in the northeast and along the west coast also have higher-than-average costs of living that should be taken into account.
Tennessee: An Example
As an example, let's say you live in Nashville. You won't pay tax on your income after 2020 if you earn $800 a week from your job, but you can expect to pay a 9.25% sales tax on everything you buy if you spend $600 of that paycheck every week. This works out to $55.50 per week on taxes.
You could swap out the sales tax with a 6.93% income tax, and your total tax burden would remain the same.
The Effect on Your Federal Tax Return
It used to be that you could claim a tax deduction for state income taxes you paid if you itemized on your federal return, and you can still do that...sort of. The Tax Cuts and Jobs Act (TCJA) capped this deduction at $10,000 when it went into effect in 2018, 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 on their federal returns.
The Bottom Line
Spending habits and lifestyles can vary dramatically, and so do the taxes that families face. You might not have to worry about higher property taxes if you don't plan on owning a home. You should understand all the quirks to local tax law before you can truly compare your potential tax burden in different states.
The information contained in this article is not tax advice and it's not a substitute for tax advice. State and federal laws change frequently, and the information in this article may not reflect the most recent changes to the law. Please consult with an accountant for current tax advice.
Tax Policy Center. “The State of State (and Local) Tax Policy.” Accessed Oct. 21, 2020.
Alaska State Legislature. ”History of Alaska Individual Income Tax.” Accessed Oct. 21, 2020.
Tennessee Department of Revenue. “What Is the Hall Income Tax Rate?” Accessed Oct. 21, 2020.
New Hampshire Department of Revenue Administration. "Frequently Asked Questions—Interest & Dividend Tax." Accessed Oct. 21, 2020.
AARP. "States That Offer the Biggest Tax Relief for Retirees." Accessed Oct. 21, 2020.
Center on Budget and Policy Priorities. “States Should Target Senior Tax Breaks Only to Those Who Need Them, Free Up Funds for Investments.” Accessed Oct. 21, 2020.
Kansas Department of Revenue. "Frequently Asked Questions About Individual Income." Accessed Oct. 21, 2020.
Tax Policy Center. “Social Security and Pension Income.” Accessed Oct. 21, 2020.
Alabama Department of Revenue. “Income Exempt From Alabama Income Taxation.” Accessed Oct. 21, 2020.
Pennsylvania Department of Revenue. “Gross Compensation.” Accessed Oct. 21, 2020.
Hawaii Department of Taxation. “Hawaii Resident Income Tax Instructions.” Page 14. Accessed Oct. 21, 2020.
Tax Foundation. “How Much Does Your State Collect in Property Taxes Per Capita?” Accessed Oct. 21, 2020.
New Hampshire Department of Revenue Administration. “Frequently Asked Questions - General.” Accessed Oct. 21, 2020.
Tax Foundation. “State and Local Sales Tax Rates, 2019.” Accessed Oct. 21, 2020.
Washington State Department of Revenue. “Motor Vehicle Fuel Tax Rates.” Accessed Oct. 21, 2020.