Various State Income Taxes: The Good, the Bad, and the Downright Ugly

When choosing where to live there are many factors that we take into consideration: proximity to friends and family, career opportunities, geographic/climate preferences, etc. While many of these choices are preferential to the individual, there is another factor that is likely unanimously one-sided: Cost of living. Who wouldn’t prefer it to cost less to live where they desire? In this article, we will be diving into one specific aspect of that cost: income taxes. The states levy these taxes in various fashions, thereby creating significant disparity between them.

First, there are seven states that do not levy any income taxes whatsoever: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, and Wyoming. Another positive of these no-tax states is that there is no tax return required to be filed. Rounding out the list of favorable states are Washington, which only taxes capital gains over $250,000, and New Hampshire, which only taxes interest and dividends. One final thought here – income is only one of the ways states levy taxes to generate revenue, so it is important to also consider the other taxes for things like property ownership, sales of goods/services, and estate/inheritance.

Other than the effectively/nearly 0% tax rate of the above states, income tax rates range from Arizona’s 2.5% up to a high of California’s 14.4%. A large majority of states fall between 4% and 6%. There is also the factor of progressive systems vs. flat rates. About a dozen states impose a fixed or flat tax rate on income, such as Illinois at 4.95%. Whereas a progressive system, similar to federal taxes and the aforementioned California, segments the income into brackets and charges an increasingly larger percentage as those brackets are filled. Continuing with California as an example, that 14.4% rate only applies to the income that exceeds $1,000,000. The effective tax rates that would get applied to the income for these states could vary wildly depending on the amount of income.

Next, there is the matter of whether a state has county or city taxes, as well. This is an often-overlooked factor in determining total tax rates and can make a seemingly low tax state closer to average or worse. Take Indiana for example: it has a comparatively low flat tax rate of 3.23%. County taxes for the state, however, range from 1% to 2.9%. An effective tax of 4.23% would still be considered low, but increasing it to 6.13% would now be considered rather high compared to other states.

Lastly, it is important to note that not all states tax all types of income. While Washington and New Hampshire opted to only tax one type of income, many states have opted to exclude specific income from being taxed. This is namely retirement income. All but 12 states have opted not to levy a tax on social security, and a few (aside from the no tax states) have also decided not to tax pensions and/or 401(k)/IRA distributions. For a retiree, it is possible that a significant portion of income is derived from these sources.

For planning purposes, all this complexity creates potential opportunity. Planning a change in residency and expecting a big windfall of income? You may want to delay or expedite that move to save on the taxes. Moving from a state that doesn’t tax retirement income to one that does? You may look to distributing from the IRA earlier or completing a Roth conversion. Comprehensive planning seeks to provide clarity about the financial impact of the options life presents such that a decision can be made in a more informed way and the effect on state taxes is one of those impacts. Please contact your JMG advisor with any questions that you might have. We invite you to share this article with others who may also find it helpful.

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