How does taxation differ from state to state?

Before diving deep into the intricacies of income taxes in the United States, you must understand that wherever you live, you will be liable to pay federal taxes. The federal income tax system is a progressive tax system with a rate that increases as your income increases. Under this system, your income is broken down into brackets, and each bracket is charged a different rate. The income brackets and their corresponding tax rates for a single (non-married) resident of the United States for the tax year of 2020 are as follows:

Variations to these brackets exist for people with different marital statuses. For more information on federal taxes, you should contact a tax advisor or use tax-preparation software like TurboTax or Sprintax. You can also visit www.usa.gov/taxes for more information. 

State and Local Taxes

State taxes can be divided into income taxes and sales taxes. Income taxes are directly levied on your earned income, and sales taxes are levied through the purchase of goods and services. 

Income Taxes

In terms of state income taxes, most states employ a progressive or flat tax rate for residents. States that are exceptions and have no state income taxes are:

• Alaska
• Florida
• Nevada
• South Dakota
• Texas
• Washington
• Wyoming
• New Hampshire
• Tennessee

While some of these states might tax interest income and dividends (New Hampshire, Tennessee), they do not touch your earned income. 

Flat-rate income taxes

Flat-rate income taxes simply deduct a fixed percentage from your earned income to go towards state tax contributions. As of 2020, these states charge a flat-rate income tax to their residents:

• Colorado - 4.63%
• Illinois - 4.95%
• Indiana - 3.23%
• Kentucky - 5.0%
• Massachusetts - 5.05%
• Michigan - 4.25%
• North Carolina - 5.25%
• Pennsylvania - 3.07%
• Utah - 4.95%

While most of these taxes offer deductions for low-income households and individuals with different marital statuses, it will be in your best interest to dig deep into your state’s individual tax policy and consult a tax advisor for more information. 

Progressive income taxes

All of the rest of the states follow a similar system to the federal government’s progressive taxation policy. This system levies higher tax rates on higher levels of income where it is split into ‘brackets’ with a marginal tax rate assigned to each bracket. Some states follow the brackets assigned by the federal government, and others set their own brackets. Some states fluctuate their brackets on an annual basis to adjust for inflation, and some keep them consistent. 

The map below highlights the maximum marginal tax rates across different U.S. states.

Image 1. State Individual Income Tax Rates and Brackets for 2020 (Loughead, 2020). 

As you can see, California has some of the highest income tax rates in the country. Again, the tax brackets, actual tax contributions, and deductions can differ from person-to-person depending on the type of household and marital status. 

Sales Taxes 

Retail sales tax is an additional strategy used by state and local governments to earn revenue in order to fund municipal funding, welfare, and other initiatives. Widely seen as a more transparent and fair way of charging taxes, most states in the U.S. employ this type of tax. In addition, a lot of localities, cities, and counties charge their own version of sales tax on retail purchases as well. The map below provides a good picture of the average population-weighted local taxes and state sales taxes across the U.S. by combining both.

Image 2. State and Local Sales Tax Rates, Midyear 2020 (Cammenga, 2020).

While California has the highest state-level tax, Alabama has the highest average local sales taxes, which props it up to #1 on the scale. It is important to note that these numbers are weighted-averages, and the actual effective sales tax rate can vary vastly depending on locality and region. 

Conclusion 

Overall, the tax system and contributions that you are liable for can vary significantly across different regions in the United States. If you are planning on relocating to a different state, make sure you do your research on the local and state tax system. Alternatively, you can use a tax-preparation software like Turbotax or Sprintax, or you can hire a financial advisor to assist in your tax planning process. 

References

 Cammenga, Janelle. “State and Local Sales Tax Rates, Midyear 2020.” Tax Foundation, 7 July 2020, taxfoundation.org/state-and-local-sales-tax-rates-2020/.

 Loughead, Katherine. “State Individual Income Tax Rates and Brackets for 2020.” Tax Foundation, 17 June 2020, taxfoundation.org/state-individual-income-tax-rates-and-brackets-for-2020/.