When it comes to filing taxes, most of us know we have two separate forms -- federal and state income tax. But for the lucky masses in the seven states that don't have income tax, they've got one less form to worry about. But what exactly is income tax, and why are these states exempt?
For starters, state income tax is the tax imposed by state governments on the income individuals or businesses in that state receive during the fiscal year.
As of 2018, the seven states that don't impose an income tax are: Wyoming, Alaska, Texas, Washington, Florida, Nevada and South Dakota. On top of that, New Hampshire and Tennessee are known for having an extraordinarily low rate.
For residents in seven states, however, state income tax is not a factor. Despite how good getting a tax break might sound, these states often have trade-offs in the form of high gas or grocery prices, which can often tend to level the field with other states that do impose state income taxes. So, even if these lucky seven don't have to take the extra time to file a second tax form, they may be paying in other ways.
Before you consider selling your home and moving to one of these states, take note of the additional taxes they might levy on you.
Wyoming seems to take the cake among low tax states. The state boasts no personal state income tax (much like the rest of these states), but, as an added bonus - Wyoming doesn't impose corporate state income taxes either. In addition, the state won't tax retirement income, and as of 2018 has an average effective property tax rate of only 0.62%, while its average sales tax rate sits at 5.49%. However, as a catch, Wyoming does have hefty property taxes and taxes on businesses involved with producing natural resources like coal and others.
Still, as far as personal income goes, Wyoming does present a nice spot to retire given the absence of personal income and retirement taxes.
Since repealing it in 1980, Alaska is state income tax-free. And, as an added bonus, the state has no sales tax either. To top things off, every Alaskan resident receives additional cash from the Alaska Permanent Fund Corp. each year.
But, Alaska has got to make money somehow - and they do this by levying other taxes like high estate, severance, excise, and gift taxes. Additionally, since one of Alaska's main sources of revenue comes from its huge oil drilling and gas production, and the price of oil has been on the decline, legislators in the Last Frontier have suggested bringing back state income tax. Still, it seems as though Alaskan residents are safe from the state-wide tax as of now, although some municipalities are permitted to enforce local sales taxes.
Thanks to the good old Texas Constitution, personal state income taxes are permanently forbidden. However, instead of hiking up revenue through income taxes, Texas has pretty hefty sales and use taxes, to the tune of around 8.25% in some areas, as of 2018. And, Texas also boasts the fourth-highest property taxes in the country -- so despite the break from personal state income taxes, residents still get a formidable sum taken out other ways. In fact, government bills are largely paid by additional sales taxes in different jurisdictions.
Despite the lack of state income taxes, Washington holds its position as the state with the fifth-highest sales taxes in the country. However, Washington residents voted to keep state income tax out, even for the wealthiest top percent. The state's sales tax rate comes in at around 6.5%, with additional local sales taxes bringing the average up to around 9%. Quite the trade-off.
No state income taxes for the Sunshine State residents (ever since 1855)! But, as is common with many states on this list, Florida does wield heavy sales taxes over its citizens, to the tune of about 6%. And, to top it off, Florida has one of the highest property tax rates around - almost 1%. Still, Florida remains an enormously popular retirement spot.
Nevada is state income tax-free -- thanks to gambling. Yes, you read that right. Nevada's government derives a large part of its funds from sales tax from tourism and gambling, earning it around a billion dollars a year. But its hefty sales tax (coming it around 6.85%) is a principle way the state gets around the no-state-income-tax break.
7. South Dakota
Unlike its northern counterpart, South Dakota doesn't tax state income - but it makes up for it in creative ways. According to Bankrate, South Dakota's Department of Revenue Special Tax Division has found ways to impose excise taxes on things like cigarettes, alcohol beverages, banks, and even a fee on coin laundromats. Still, despite several attempts to reinstate the state income tax that was repealed in 1943, South Dakota remains a very retirement-friendly state, boasting one of the lowest sales taxes in the entire country. Additionally, the Mount Rushmore state also claims a very average property tax, keeping living costs fairly low.
States that Don't Tax Wages
However, two states - New Hampshire and Tennessee - don't tax a large portion of wages, earning them honorable mentions as pseudo-state-income-tax-free states. In fact, Tennessee is on course to become the actual eighth state without state income tax, as the Hall tax imposed by the state (which stood at 6% on interest and dividend income but is gradually being decreased yearly by 1%, and now is around 3% in 2018) will likely be null by 2020.
Additionally, New Hampshire has some of the most lax taxing on interest and dividend income, reportedly only charging taxes on interest and dividend income over of $2,400 (or $4,800 for married or joint filing couples, plus an extra $1,200 for people 65 or over, blind or disabled). The state income tax is only 5% in general.
Is it Cheaper To Live In a State Without Income Tax?
Well, the short answer is - not necessarily.
Several of the states on the "no-state-income-tax list" are some of the top states for high sales or property taxes - especially Texas and Washington. Additionally, lots of states raise funds through either high gas prices, groceries, property, or sales taxes. Tennessee imposes the highest sales taxes in the country, while New Hampshire and Texas have among the most expensive property taxes in the nation. And, Washington's gas prices continue to be among the most pricey.
Additionally, although not a rule, most of the seven states also have high living costs including Florida, New Hampshire, South Dakota and Washington, according to the Center for Regional Economic Competitiveness -- which may add up against the benefit of not having to pay state income tax.
In that vein, before up and moving to one of these states, it is important to understand that, for the most part, it's a trade-off -- whether in the form of higher sales or property taxes or having a higher-than-average cost of living or other taxes.