Which States Have a Flat Income Tax Rate?
Do you live in one of the eight "flat tax" states?
Taxes can be complicated enough without adding a new term or wrinkle like "flat" tax. Do you live in one of the states that uses this tax system? How is it different?
What Is a Flat Tax Rate?
A flat tax rate is exactly what it sounds like—it's flat and even across the board. All taxpayers pay the same rate regardless of how much they earn. The concept has a lot of supporters, but it's met with its fair share of opposition, too.
Supporters say that it encourages wealth because top earners aren't punished with higher tax rates. The system is far simpler and some say it's much fairer than the progressive tax system that's in place in most states. Odds are that you don't live in one of the states that use this system because there are only eight of them as of 2017, but here's what you need to know if you do.
So What's Wrong With a Flat Tax System?
Opponents of the flat tax system argue that it actually places an unfair burden on low-income earners. The tax rate ranges from between about 3 percent to more than 5 percent of income, and it also eliminates many tax deductions and exemptions so earners pay taxes on more income.
Giving up 5 percent of $100,000 in income leaves plenty of money for fixed-cost necessaries like a gallon of milk, but 5 percent of $10,000 might put that milk out of reach. The argument is that this forces more low-income residents to look to public assistance to help make ends meet.
As for the middle class, opponents say that the flat tax can negatively affect them, too—and by extension, the economy—because it doesn't really encourage investing or saving toward retirement through tax breaks. But that argument doesn't really hold water because the tax rate in flat tax states doesn't always apply to unearned income like interest from investments and capital gains from the sale of assets.
Taxpayers who can afford to invest and make their money grow can realize these profits tax-free, at least at the state level.
A Comparison of Flat Tax States
Tax concepts are rarely black and white, and specific rules can differ among the states that have adopted a flat tax system.
- Colorado: The tax rate here is 4.63 percent of your federal taxable income. Colorado passed legislation in 2016 to provide a $5,000 tax credit for electric vehicles, but it offers no standard deduction or personal exemptions.
- Illinois: Although this state considered doing away with its flat tax system in 2016, the legislative pendulum ended up swinging the other way. The flat tax rate actually increased instead, from 3.75 percent to 4.95 percent of federal taxable income. There's no standard deduction, but personal exemptions range from $2,175 to $4,350 on joint married returns as of 2017.
- Indiana: The flat tax rate actually dropped a little here in 2017, from 3.3 percent to 3.23 percent. It might be a miniscule difference, but every little bit helps. Personal exemptions are modest, just $1,000 if you're a single taxpayer up to $1,500 for each of your dependents and $2,000 for married couples who file jointly.
- Massachusetts: The flat tax rate in Massachusetts has held steady at 5.1 percent for a few years now. There's no standard deduction, but personal exemptions are somewhat generous at $4,400 for single taxpayers and double that for married taxpayers filing joint returns. Unfortunately, you get only a $1,000 exemption for each of your dependents.
- Michigan: This state has taxed income at a flat 4.25 percent since October 2012. Voters resoundingly vetoed a flat tax rate increase in May 2015, prompting lawmakers to consider a "graduated" version of the tax instead, but no such legislation is pending as of 2017.
- North Carolina: North Carolina taxes income at a flat 5.499 percent, the highest rate among all states that use this tax system. This state enacted its flat tax system in 2014 and eliminated its earned income tax credit and personal exemptions at the same time, as well as deductions for medical expenses, retirement contributions, child care and college 529 plans. Personal exemptions have been added back into the tax code as of 2017, however: $8.750 for single filers and $17,500 for married couples filing jointly. But there are still no exemptions for dependents.
- Pennsylvania: The tax rate here is the lowest among flat tax rate states at 3.07 percent. Pennsylvania law does not recognize tax exemptions for individuals or their dependents.
- Utah: The tax rate here is 5 percent. Although the state does not technically have a standard deduction, it does offer a nonrefundable tax credit equal to 6 percent of your federal deduction and it allows personal exemptions.