Posted by Fred Lake

What Is State Income Tax and Why Do Some States Have One?

What Is State Income Tax and Why Do Some States Have One?

It is not only Uncle Sam that wants a slice of your paycheck. Some states also levy their citizens some percentage as a paycheck. They use the revenues from such tax to provide public services to the residences. These taxes are used to fund the goods and services they provide like health, infrastructure, defense, education, and roads. 

Of all the 50 states, 41 impose an individual income tax, Louisiana included, while seven states do not. These seven states make up for their taxes in other ways like high property taxes, low sales taxes, etc.


Why Do Some States Not Have Income Tax?

The state income tax applies at the state level, so the tax rate decision falls in the hand of lawmakers. A state that does not impose income tax could do so in a bid to attract new people to settle in the state, increase revenue from other sources, or simply their belief towards the tax system. 

The 1970 oil boom in Alaska repealed the state income tax. This was because the lion's share of Alaska's revenue came from oil activities. The state concluded that it could finance itself from oil proceeds, so there was no need to tax residents. 


People Earning Income in the Other States 

It is important to report income from other states in your home state tax if you are located in a state without an income tax. This applies even if the revenue comes from a tax-free state. The same rule applies for the other way – Living in a tax-free state and receiving income in a state with income tax, it is pertinent to include it in your tax. 


Retirement Income Taxes

There are 43 states that impose a kind of income tax, but some of these, including Louisiana and the District of Columbia, do not burden retirees. This means income tax in these states does not apply to many seniors after retirement. While some of these states exempt a portion of the retirement income, others exclude the real income. 

Here is a list of states that do not tax social security income:

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 

As long as someone meets some income requirements, there are full or partial exemptions from other states. For instance, Kansas will not tax your social security income provided your AGI from your complete source is $75,000 or less.


Other Taxes in These States

It is essential you understand many things before deciding to move to a state you feel is tax-friendly. It is important to note that these states will have to raise their revenues in another way to keep up with the state function. 

States with no income tax do make up for these via excessive property taxes, fuel taxes, sales tax, and other taxes. When you do the math, you might be paying more than what you will pay in a state that taxes your income at a fair rate. 

In the country, Texas and New Hampshire have some of the highest avg. Property tax per capita, even though New Hampshire has no sales tax. In the US, one of the states with the highest sales tax in Tennessee.

States located along the west coast and northeast have a pretty high standard of living. 


Implication on your Federal Tax Return 

The silver lining is that there is a provision to claim a tax deduction if you paid state income tax provided you itemize on your federal tax return. This deduction is, however, capped at $10,000 by the TCJA. This $10,000 limit also includes the property tax. 

If you are not paying income tax, there is the provision to deduct all or most of your property tax from your federal tax return. 


Conclusion 

When you consider how individuals vary in terms of spending habits, preferences, and lifestyle, it is not surprising that taxes also vary. With this, a high property tax might never be your headache if you do not have a house. 

As a result, one needs to understand everything about local tax laws to have a reasonable comparison of tax burdens in various states.


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Fred Lake
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