9 States With No Income Tax
In this article, you will get to know what it means to live in a state without an income tax. We would also tell you the pros and cons of living in a ‘no income tax’ atmosphere and how it may impact your cost of living. In the end, we would provide an analysis of how these states with no income tax cope with other taxes and cost of living
You may have wondered how it would be about living in a state with no income tax. You may have thought it would have been really nice as it would have lowered your overall tax burden. Here is a look at the benefits of living in a state with no income tax and the possible drawbacks that you may expect.
As of 2021, 8 states Alaska, Nevada, Florida, Tennessee, South Dakota, Wyoming, Washington and Texas -do not levy a state income tax on their residents. New Hampshire, the 9th one, does not levy tax on earned income. However, it imposes a 5% tax on interest and dividends. This system is expiring in the year 2027.
How is it to Live in a State without any Income Tax?
Living in a state with no income tax obviously means you can keep a bit more of your income. Compare it with a resident of California who needs to cope with high personal income tax rates (where portions of his income may get taxed as high as 13.3%). He may be very much tempted to relocate to an ‘income tax free’ state such as Washington. However, relocating to a state without an income tax will not imply he will be excused from paying other types of taxes. If he is liable to file a federal return, he would still be required to do so before the deadline.
Read Also-: What are the Income Tax Brackets for 2022 vs. 2023
Advantages and Disadvantages of Living in a State without Income Tax
🔹 Establishing Domicile
If you want to reap the advantages of living in a state without an income tax, you need to meet certain conditions. The intention of making such a state your permanent home (termed Establishing domicile) is the most important among them. In general, to qualify as a permanent resident, you must reside in a place for a minimum of 6 months during the relevant year. The State will conduct residency audits and hence, you will need to provide sufficient proof against your claim. However, such rules and requirements often vary from one state to another.
You need to be careful here. If you live in one location (for example, New York) but spend the better part of the year in a different state (for example, North Carolina), you may be regarded as a permanent resident of one state and a “statutory resident” of the other state for tax purposes. This would mean that you may end up paying income taxes in both these states. To avoid such sticky situations, we would recommend you consult with a tax professional.
🔹 Retirement Benefits
In most states, people usually pay at least some taxes upon retirement in the form of 401(k) distributions, Social Security benefits or pensions. However, in the states without a personal income tax, the residents usually are not required to pay the state taxes on retirement plans. This means they get to keep more money for the golden years.
Avoiding such additional taxes may seem to be a good retirement perk. But, you would do well to weigh the tax benefits against other important personal and financial considerations. To give you an example, some of these states may have inadequate options for public transportation, minimal funding for senior care programs, higher property taxes or less affordable health care. Before relocating to such states, you should gather proper information about all these and make informed decisions.
🔹 Quality and Cost of Living
Cost of living should be the most critical decision-making criterion for you. It includes the costs of housing, wages, food, lifestyle and health care. The savings you have made on state taxes may not cover you against the extra cost you may incur to live comfortably in that particular state. For example, let us assume you are currently living in Buffalo, New York, on a salary of $55,000. You would need to earn more than $70,000 to maintain the same standard of living in Anchorage, Alaska. This means you will need to earn an additional $15,000 to cover increased housing, transportation, food and health care costs.
Think from your job perspective as well. As remote work is becoming the new norm these days, it is possible now to move without risking job security. Moving to live in a state with no income tax may limit job opportunities in your particular industry. Any possible disruption in your employment may invite difficulties for you in future.
🔹 Other Taxes
State taxes often generate revenue for funding infrastructure or boosting services such as health care. Without this flow of revenue, some states are forced to rely heavily on other forms of taxes, such as sales and property tax, to cover the loss. Therefore, if you are a house owner residing in a state with affordable property taxes, you may face a different scenario after relocating to a state with no income tax. You may save on state income tax but the increased property tax may dig a deep hole in your pockets
There is one positive side as well. Barring New Hampshire, all the income-tax-free states do not tax the capital gains earned by the residents. This means you will need to pay for your capital gains only at the federal level.
How the States with no Income Tax Cope with other Taxes
Florida is a popular destination for vacationers and retirees. Most of its revenue comes from tuition through state universities and state & local sales tax. These compound to an overall state and local tax burden of 8.8%. The cost of living may not be too high for most people, but they still need to cope with a competitive housing market. As per the U.S. News & World Report, Florida is marked 41 on a scale of 50 for housing affordability.
Alaska is considered one of the most tax-friendly states in the U.S. It repealed personal income tax in the year 1980 and started taxing oil and gas production companies at high rates to cover the loss of revenue. The mean effective property rate in Alaska is 0.98%, and its overall state and local tax burden is as low as 5.8%. However, because of its remoteness, Alaska is expensive in many ways. As per the U.S. News & World Report, Alaska is marked 47 on a scale of 50 for affordability. Higher-than-average housing costs and a high cost of living contribute to this. Most residents are provided with an annual stipend (named the Alaska Permanent Fund Dividend), of up to $2,000, to help them offset some costs.
The overall state and local tax burden in this state is 9.7%, which is considerably higher. A majority of the tax burden is covered by sales and excise tax and taxes on tourism and hospitality industries such as gaming and hotels. Nevada is ranked lower on the affordability scale of U.S. News & World Report ( 41 out of 50). This is contributed by high housing costs. However, the effective property tax rate is on the lower side at 0.56% only.
🔹 South Dakota
South Dakota is often regarded as one of the most popular locations amongst retirees. This state is the home to Badlands National Park and Mount Rushmore. It is also the highest-ranking state on the list of affordability by the U.S. News & World Report. It is ranked 14 out of 50 on this list. The credit goes to its combined housing and cost of living scores. The overall sales and local tax burden in South Dakota is 9.1% and it generates most of its revenue from sales and excise taxes- by levying taxes on items like alcohol, tobacco and motor fuel. The effective property tax rate of 1.14% may not be too pleasant for homeowners.
🔹 New Hampshire
Contrary to other states, New Hampshire taxes interest and dividends at a 5% on investment income. This is scheduled to reduce by 1% every year until it ceases to exist in 2027. New Hampshire doesn’t impose sales taxes but imposes excise taxes on certain goods like tobacco. As per the Tax Foundation figures, the overall state and local tax burden in this state is 9.7%. New Hampshire ranks well enough for housing affordability, but the property taxes and the cost of living are on the higher side. The mean effective property tax rate here is 1.89%, which is the third-highest in the U.S.
It is the second-largest state in the country, famous for its “go big or go home” attitude. Aversion to income taxes is very strong here and the ban is mentioned in the state constitution. The state and the local tax burden is 8%, which is one of the lowest in the U.S. However, at 1.6%, the effective mean property tax rate is on the higher side. If you leave the taxes part alone, living in Texas has its fair share of perks. It is ranked 22 out of 50 on the affordability scale of U.S. News & World Report. It is also ranked 14 out of 50 for its cost of living standards.
In 2017, Tennessee started the phased approach to repeal the Hall Income Tax that was used to tax dividends and interest on investment income. It got completely eliminated in 2021. As per Tax Foundation data, Tennessee imposes a relatively higher sales tax, and it levies a tax on items like fuel, alcohol, fantasy sports contests, beer and so on. Yet, at 7%, it has the second-lowest overall tax burden in the country (with Wyoming). Moreover, the effective property tax rate in this state is 0.63%. As for affordability, it is ranked 17 on the scale of the U.S. News & World Report.
According to the 2020 Census data, Wyoming is the least populated state in the country. With a 7% overall sales and local tax burden, it is tied with Tennessee as the second-lowest in this category. As there is no income tax, Wyoming relies on sales and excise tax, property tax and oil tax to cover the loss. The U.S. News & World Report ranks it 33 out of 50 on its affordability scale.
Washington not only waives personal income tax, it also does not levy a corporate income tax. This is attractive to the major corporations headquartered in the state. The overall sales and local tax burden in this state stands at 9.8% which is average if you compare it with other states. This state falls short on affordability and is ranked 44th on the affordability scale of the U.S. News & World Report. High housing cost is the major contributor to this.
Read More-: 2021-2022 Tax Brackets and Federal Income Tax Rates
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