The other states either have a graduated-rate individual income tax (32 states) or a flat income tax or an alternative tax structure (nine states). Knowing how income taxes work in your state can help you plan for your tax bill every year.
Why Do Some States Charge No Income Tax?
State income tax is set at the state level, not the federal level, so it’s entirely up to state lawmakers. Their reasons for not having income taxes could be driven by their ideals for tax policy, as an incentive to attract new residents, or because they derive revenue from another source. For example, state income tax in Alaska was repealed after an oil boom in the 1970s. The overwhelming majority of the state’s revenue comes from oil-industry activity. Alaska decided that it could receive most of the revenue it needed from the oil industry, so the state no longer requires taxes on residents’ incomes.
Tennessee and New Hampshire Income Tax: Gone and Going
Tennessee gradually reduced its “Hall tax” on interest and dividend income. The state’s 6% Hall tax rate was reduced by 1% increments each year until the tax was eliminated on Jan. 1, 2021. New Hampshire assesses a 5% tax on interest and dividend income beyond $2,400. Interest and dividend income aren’t taxed for married couples filing joint returns until that amount exceeds $4,800. An additional $1,200 exemption is available for certain taxpayers who are disabled, blind, or over the age of 65. The tax on interest and dividends is being phased out over a five-year period. As a result, new Hampshire will officially have no income tax by 2026.
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
If you’re retired military, 34 states do not tax your military pension; nine of these are the states without income taxes or ones that only tax dividends and interest. Income tax on traditional retirement is limited in 27 states, depending on your income. Other states have partial or full exemptions for people who meet specific income requirements. For example, Kansas exempts Social Security income if your adjusted gross income (AGI) from all sources is $75,000 or less. Pennsylvania also exempts private-sector pension income, and Alabama doesn’t tax income from defined-benefit retirement plans and many other types. Hawaii doesn’t tax income from contributory retirement plans, nor does it tax Social Security payments.
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. That means they have to get their money from somewhere. States without an income tax often make up for the lack of these revenues by raising various other taxes, including property taxes, sales taxes, and fuel taxes. These can add up so that 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 has some of the highest average property taxes per capita in the nation. 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 68 cents per gallon. States in the northeast and along the West Coast also have higher-than-average costs of living.
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. 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 certain property taxes as well.
