Finding a Low-Tax State

May 9, 2015

Many people today are not tethered to a job location, so they can choose where to live. Those in this category range from retiring Baby Boomers, ready to relocate, to new graduates about to enter the work force. Others who can pick their place of residence include certain self-employed individuals and people who are employed but able to work remotely, thanks to today’s technology.

If you can choose where to live, you might weigh many factors, from desirable weather to the proximity of family and friends. A low cost of living, especially when it comes to housing, also can play a role. Another key living cost will be the level of taxation you’d face in a given state.

Income taxes

When you think of taxes, income tax might be your primary concern. Some states (Alaska, Florida, Nevada, South Dakota, Texas,
Washington, Wyoming) have no personal income tax, whereas Connecticut and Tennessee tax only certain amounts of investment income. At the other end of the spectrum, many counties, cities, and school districts across the nation impose an income tax, in addition to state tax. For example, it’s common for New York City residents to be in a combined (city and state) income tax bracket of over 10%.

That said, you should look closely at an area’s complete income tax situation before crossing it off your list. Some states offer attractive
tax benefits to retirees, including full or partial tax exemptions for Social Security benefits, pensions, and distributions from tax-favored retirement accounts such as IRAs. Thanks to federal legislation, people who relocate to a different state won’t owe tax to their old state
on retirement plan distributions. Seniors might owe little tax, even in a supposedly high-tax state, if they have scant earned income or taxable investment income.

In addition, the state or local income tax you pay might be deductible for federal income tax purposes, reducing the effective tax rate.
Example: Walt and Vicki Taylor are in the 25% federal tax bracket. This year, they pay 8% of their $100,000 taxable income in state and local income tax, taking an $8,000 itemized deduction for those outlays. By reducing their federal taxable income by $8,000, the Taylors save
$2,000 in tax (the $8,000 deduction times their 25% federal tax rate), reducing their net state and local tax cost from $8,000 to $6,000, or 6% of their income.

That’s a simplified example, as the actual calculation can be complicated. If the Taylors wind up owing the alternative minimum tax (AMT), they’ll get no deduction for their state and local income tax payments, so their actual cost would be 8%. The same is true if the Taylors take the standard deduction, so they don’t deduct their state and local taxes. Our office can help you determine the true income tax rates of a given area.

Other taxes

Although income taxes are certainly noticeable, you shouldn’t focus solely on them. In most states and cities, you’ll owe other types of taxes, which you should include in your comparison.

Previously, an example showed the Taylors owing $8,000 in state and local income tax. If the Taylors are homeowners, they could pay $10,000 or more in property tax, in some areas. Moving to a state with little or no income tax might not be a good choice if the area where you plan to buy a home charges extremely high property tax. Indeed, steep property taxes that increase in the future could make a retirement home unaffordable, forcing you to sell. As is the case with income tax, you should calculate the net cost of property tax payments, after any likely federal tax deduction.

Sales taxes also should be considered. Altogether, comparing taxes from one residential location to another can be complicated. Again, our office can help you estimate your tax burden in an area you’re considering for a new home. Just keep in mind that taxes are only part of the cost of living at a particular address, and the total cost of living is merely one aspect to consider when deciding where to live.