State income taxes
State income taxes
|Strategic Tax Considerations|
Tax-managed fund comparison
Taxation of Social Security benefits
|Tax Loss Harvesting|
|Specific Identification of Shares|
|Tax Gain Harvesting|
|Tax gain harvesting|
|Vanguard fund distributions|
State income taxes do not always work the same way as Federal taxes. Understanding the differences specific to your state may be useful in making investment plans, and people giving advice to investors in other states need to know other state-specific issues. This page is a summary of the major differences between state and federal taxes, with links to each state's tax page. If your state is not listed on this page and you know something about the state tax, please add it.
In most states with an income tax, the tax works essentially the same as the Federal tax. You compute your total income, subtract itemized deductions or a standard deduction. subtract personal exemptions (or, in some states, take a dollar credit for personal exemptions), and pay a tax based on the tax rate; the only difference is that certain items are taxed differently. States in which the tax works in a very different way (for example, no standard deduction and only limited itemized deductions, or only some types of income taxed) will be indicated below.
States with no income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington, Wyoming
States with flat rates: Colorado, Illinois, Indiana, Massachusetts, Michigan, Pennsylvania, Utah
New Hampshire and Tennessee tax dividends and interest income only.
Interest and dividends
States cannot tax the Federal Government; therefore, interest on Government obligations, such as Treasury bonds and TIPS (but not GNMAs), is exempt from state tax. On the other hand, most states do tax obligations of other states, so income from municipal bonds from other states is exempt from Federal tax but subject to state tax. In most states, if a fund contains a mixture of taxable and tax-exempt income (for example, a bond fund holding both Treasury and corporate bonds), the tax-exempt income is not taxed by the state; some states require a minimum percentage of the fund to be tax-exempt to get any tax benefit.
Most states do not allow an itemized deduction for state and local taxes, although some allow the deduction for taxes paid to other states or out-of-state localities, and Hawaii allows a deduction for taxes paid to all states. A few states allow a deduction for Federal taxes, which significantly reduces the effective tax rate.
Multiple state tax issues
States that impose a personal income tax generally require that tax be paid on all income earned in that state, as well as all income earned by residents of the state. This may result in the need to pay taxes to multiple states, but there are provisions to reduce both the tax and the paperwork burden.
Reciprocity with neighboring states
For employees who work in one state but live in another, a tax return must be filed in both states. To alleviate this double filing burden, many neighboring states have agreements not to tax salaries earned by each other's residents. This makes taxes easier to handle for commuters, as most commuters have no income earned in the other state except for salaries.
Generally, under these agreements, one state will not tax a resident of the other state on compensation that is subject to employer withholding. These agreements apply to most types of W-2 compensation earned while a resident of the reciprocal compensation agreement state. For convenience, an employer may withhold taxes at the employee's resident state tax rate.
For example, a Pennsylvania resident working in New Jersey (PA has reciprocal agreements with NJ and 4 other states) could have taxes withheld for PA at the PA rate. Only a PA state tax form is needed; no additional forms are to be filed for New Jersey unless the resident owes New Jersey tax for some other reason (for example, property sold in New Jersey).
Credit for taxes paid to another state
If you pay taxes to two states on the same income (because both consider you to be a resident, or because you are a resident of one but earned income in the other), the states allow a credit analogous to the foreign tax credit. The credit is usually the lesser of the amount you paid to the other state, or a prorated share of the tax you paid to the state where you took the credit.
For example, if you are a resident of State X with income of $100,000, of which $20,000 was taxable in State Y, and you paid $6000 in tax to State X, then you are entitled to a $1200 credit if you paid $1200 or more to State Y, and otherwise only a credit of the amount you paid to State Y.
Nonresidents and part-year residents
Nonresident tax is normally computed on a prorated basis. If you are a nonresident of state Y and have total income of $100,000, of which $20,000 is taxable in State Y, then you compute the State Y tax on the full $100,000, and 20% of the total is your State Y tax.
Some states tax part-year residents the same as non-residents, prorating full-year income. Other states do not prorate. In the example above, if you moved to State Y during the year and earned a total of $100,000, of which $20,000 was earned while you were a resident, and State Y does not prorate, then you would owe the tax on $20,000 rather than 20% of the tax on $100,000. If the tax in State Y is flat, this would not matter, but if the tax is progressive, you would owe much less tax because of the lack of proration.
If you do not fill out a state withholding form, most states will withhold income tax using the same number of allowances as on the Federal W-4 form. This is often incorrect, either because your itemized deductions and credits are different (since state taxes are not deductible on the state form, and most Federal tax credits do not apply to the states) or because the amount a state assigns to an allowance is different (if a state has a $1000 personal exemption, then $20,000 of extra itemized deductions is 20 state allowances). Check your state withholding when you file your federal W-4 to avoid getting a large refund or a penalty.
All states with sales taxes also impose a use tax on goods purchased out of state for use in the state by state residents; sales tax paid to another state can be taken as a credit against that tax. This tax is not part of the income tax, but in many states, there is a line on the income tax form for use tax payments to encourage compliance, and some states provide a formula for estimating the tax due if the taxpayer does not keep records.
This section is not intended to be a comprehensive guide to the details of state taxes, just a summary of the most important issues. Go to the state web site or check with a tax advisor for details.
Specific issues for investors
This section is a summary of investment strategies which may be affected by state tax issues; see the following section for a more complete summary.
- Any state with no income tax: Minor preference for Roth over traditional accounts (you may pay tax on traditional account withdrawals if you retire in another state). More attractive to pay down a mortgage (interest not deductible). More attractive to invest in corporate bonds rather than Treasury bonds in a taxable account.
- Alabama Prefer Treasury bonds in a Health Savings Account (other investments are taxed).
- Arizona Foreign investments in a taxable account are more attractive (foreign tax credit against state as well as federal tax).
- California Prefer Treasury bonds in a Health Savings Account (other investments are taxed).
- Indiana More attractive to pay down a mortgage (interest not deductible).
- Maryland Prefer not to roll an entire retirement plan into an IRA (some pension income is excluded from tax but this is lost in an IRA).
- Massachusetts Use banks in MA in preference to other banks (non-MA bank interest is taxed at a higher rate, and some MA interest is not taxed at all). More attractive to invest in Treasury or MA bonds rather than corporate or non-MA bonds in a taxable account (dividends taxed at a high rate). Prefer Roth to traditional IRA even if traditional would be federally deductible (no state deduction). More attractive to pay down a mortgage (interest not deductible).
- Michigan More attractive to pay down a mortgage (interest not deductible). For taxpayers born before 1946 without pensions, prefer traditional to Roth accounts (a large amount of retirement income is not taxed).
- New Jersey Prefer Roth to traditional accounts except for 401(k)'s (traditional IRA, 403(b), 457, Thrift Savings Plans are not deductible). Prefer Treasury bonds in a traditional IRA (not taxed; it is not clear from the instructions whether this applies to other traditional accounts). More attractive to pay down a mortgage (interest not deductible). Prefer Treasury bonds in a Health Savings Account (other investments are taxed).
- New York Prefer to have at least some traditional rather than Roth accounts; moderate-income taxpayers should prefer traditional to Roth for most retirement income ($20,000 per person excluded).
- Pennsylvania Minor preference for Roth over traditional accounts (neither is taxed in PA, but you may pay tax on traditional account withdrawals if you retire in another state). More attractive to pay down a mortgage (interest not deductible). Foreign investments in a taxable account are more attractive (foreign tax credit against state as well as federal tax).
- Virginia No special issues.
Issues to check when adding a state to the list
Here are some of the more common issues which should be mentioned:
- No income tax, or tax applied only to some types of income (investments but not salary).
- Municipal bonds from other states not taxed.
- State taxes some income excluded from Federal income on W-2 (e.g., 401(k) or 403(b) contributions).
- Tax exemptions for Social Security or retirement income.
- Taxation of Health Savings Accounts.
- Minimum fraction of income or assets in tax-exempt assets for mutual funds to be exempt from state taxes.
- No standard deduction.
- Only specific items may be deducted, rather than most Federal itemized deductions.
- Significant additional deductions such as Federal tax.
- Taxpayers must itemize state deductions if they itemize Federal deductions, or must take state standard deduction if they take Federal standard deduction.
- Different types of income taxed at different rates.
- Credit for taxes paid to foreign countries or localities in those countries.
- Earned income credit.
- Part-year resident income is not prorated, in states with progressive tax rates. (If the tax rate is flat, proration is irrelevant, as the tax on $20,000 is 20% of the tax on $100,000.)
The Specific Issues for Investors section should be kept short; only those issues which are relevant to a large number of investors (such as non-deductibility of mortgage interest or taxability of different types of investment income) should be mentioned there. The Tax Details section, which is the last section, can be long if there are important details. For simplicity and to reduce the number of changes needed annually, specific numbers (such as the amount of a personal exemption, or the tax rate) should usually not be listed unless they are very large or otherwise significant.
- Alabama; see also this unofficial site Capital losses are deducted against income in the year realized, with no limitation and thus no need for carryover. Social Security and income from defined-benefit pension plans are not taxed. Health Savings Accounts are not recognized; contributions are not deductible and income earned is taxed. $5000 of contributions to the Alabama 529 Plan is subtracted from income. Federal tax is deducted from taxable income in addition to the standard or itemized deductions. Taxpayers below certain income limits with health insurance through small employers may deduct 50% of their health insurance premiums in addition to the standard or itemized deductions, and may still deduct 100% as an itemized deduction if appropriate. All federal taxes other than income tax are deductible as itemized deductions; this includes Social Security, Medicare, self-employment tax, and gift tax if paid by the giver. Tax paid to a city or county is deductible from state tax (most states do not allow this). Qualified long-term care premiums are fully deductible, and other medical expenses in excess of 4% of adjusted gross income are deductible (compared to 7.5% for federal tax). Part-year resident taxes are not prorated, but this has little effect because the tax rate is almost flat.
- Arizona Social Security is not taxed. Income tax paid to other states is deductible. Credit for taxes paid to a foreign country, computed as for credit to taxes paid to another state. Part-year resident taxes are not prorated.
- California Health Savings Accounts are not recognized: employer contributions are taxed as income and employee contributions are not deductible, but then distributions not used for qualified medical expenses, and included in federal income, are not taxed. All interest from tax-exempt mutual funds is taxed unless at least 50% of the assets are in bonds not taxed by CA. Social Security is not taxed. Unemployment compensation is not taxed. You cannot deduct Private Mortgage Insurance, estate tax paid on income in respect of a decedent, or tax paid on generation skipping transfers. You cannot deduct losing CA lottery tickets as gambling losses.
- Delaware Taxpayers under 60 may deduct up to $2,000 of pension income; an early distribution from an IRA or Pension fund due to emergency reasons or a separation from employment does not qualify. Each taxpayer may receive one exclusion; a husband and wife who each receive pensions are entitled to one exclusion each. Taxpayers 60 and over may deduct up to $12,500 of eligible retirement income which includes: dividends, capital gains,interest, net rental income from real property and qualified retirement plans (IRC Sec. 4974). From: Delaware Individual Resident Income Tax Return Instructions
- Indiana All municipal Income exempt from Federal taxes is exempt from Indiana taxes no matter which state it comes from. State income tax deducted from federal tax as a non-itemized deduction (on schedule C, C-EZ, E, or F) is taxable. Unemployment compensation is taxed in full. Social Security is not taxed. No general standard or itemized deductions, but limited deductions for property taxes and renters. 9% of federal earned income credit allowed as state credit. Counties can charge an income tax that is paid with the state tax; tax paid to another state can be takes as a credit against state tax, and tax paid to an out-of-state county or city can be taken as a credit against county tax.
- Maryland Social Security is not taxed, and some pension income (a moderate allowance, but reduced by total Social Security) is not taxed for taxpayers over 65. 50% of federal earned income credit, plus a county credit, allowed as state credit. Itemized deductions allowed only if deductions were itemized on the federal return; standard deduction may be taken even if itemized deductions were taken on the federal return. Counties charge an income tax that is paid with the state tax; tax paid to another state can be taken as a credit against state tax, but neither tax paid to another state nor to an out-of-state county can be taken as a credit against county tax. Part-year resident taxes are not prorated.
- Massachusetts There is a 12% tax rate on dividends, interest (except from MA banks), and short-term capital gains, and deductions (except for up to $2000 of capital losses applied against dividends and interest) are not allowed against this income. Capital losses can be carried over but do not offset ordinary income. All other income is taxed at a flat rate, currently 5.3%. MA bank interest is exempt up to $100 ($200 for married filing jointly). There is no standard deduction. The only federal itemized deductions which are allowed as MA deductions are medical expenses and employee business expenses; these are only deductible for a taxpayer who itemized deductions and deducted them, although employee business expenses are deductible in full if they, combined with other miscellaneous deductions, exceeded 2% of AGI; in addition, most federal adjustments to income (HSAs, student loan interest, etc.) are deductible. IRA contributions and self-employed retirement plans, including SEP, SIMPLE, and Solo 401(k) plans of sole proprietors are not deductible; non-deductible portion is not taxed upon withdrawal. There are also deductions for 50% of rent paid (up to $3000 per return), Social Security and Medicare taxes paid (up to $2000 per person), college tuition in excess of 25% of MA AGI, undergraduate student loan interest even if not federally deductible, and up to $750 per person in transit passes or tolls over $150. 15% of federal earned income credit is allowed as a state credit.
- Michigan There are no itemized deductions; there is a 50% tax credit for small contributions to certain Michigan charities, and a partial tax credit for income tax paid to a city in Michigan. There is a homestead property tax credit for low-income homeowners and renters. 6% of the federal earned income credit is available as a state credit. Michigan Public Act 38 (signed into law on May 25, 2011) has caused drastic changes in how retirement income in Michigan is taxed:
- The new law creates three retirement income tax systems depending on year of birth. For married couples the controlling year of birth is that of the older spouse. Eliminated in the new law is the former special age 65+ personal exemption.
- Most future retirees (born after 1952) will be able to reduce their Michigan taxable income by the larger of (1) a Personal Exemption plus their federally taxable Social Security income, or (2) an Income Deduction of $20,000 per person starting at age 67. However this Income Deduction is not inflation indexed, while the Personal Exemption and Social Security benefits are increased for inflation. Consequently the Income Deduction will become negligible over time.
- Persons born between 1946 and 1952 get all three of the above income reductions (Personal Exemption, taxable Social Security, and Income Deduction starting at age 67). Before age 67, they can also utilize a partial Retirement Income Deduction (RID) of $20,000 per person, which is not inflation adjusted. The RID covers all income from pensions and traditional IRAs. Only a portion of the income from 401(k) and 403(b) plan withdrawals qualifies for the RID:
- •Employer contributions qualify
- •Employee contributions made to earn employer matching contributions also qualify.
- Persons born before 1946 are not eligible for the $20,000 per person Income Deduction. Instead, they receive a full Retirement Income Deduction of $45,120 per person (in 2011 dollars) which is increased with inflation. They also receive the Personal Exemption and taxable Social Security reduction to their Michigan taxable income.
- New Jersey No deduction for IRAs, nor any retirement plans other than 401(k) plans; non-deductible portion is not taxed on withdrawal. Health Savings Accounts are not recognized: contributions are not deductible and income earned is taxed. Capital losses exceeding gains may not offset ordinary income nor be carried over to future years. Medical insurance paid by payroll deduction (Section 125 or "cafeteria" plan) is taxed. Income and capital gains on NJ and Treasury bonds (including the prorated portion of a fund with 80% of its assets tax-exempt) are not taxed, even in IRAs. Retirement income (up to a limit) is not taxed for taxpayers over 62. Deductions allowed only for medical expenses in excess of 2% of income, and property taxes (also 18% of rent paid by renters assumed to be property tax). 20% of federal earned income credit allowed as state credit. Part-year resident taxes are not prorated.
- New York $20,000 per person of pension benefits (including IRAs) is not taxed after age 59-1/2. Itemized deductions only allowed if deductions were itemized on the federal return; standard deduction may be taken even if deductions were itemized on the federal return. All itemized deductions are reduced for taxpayers earning over $100,000 single/$200,000 joint, with considerable reductions at higher levels. $5,000 per person of contributions to the New York 529 plan is subtracted from income. Up to $10,000 per student in undergraduate tuition is allowed as an itemized deduction, or $200 or 4% of tuition may be taken as a credit; payments from a 529 plan may be used for the credit or deduction. New York City and Yonkers charge an income tax that is paid with the state tax; tax paid to another state or an out-of-state county or city can be taken as a credit against state tax but not city tax. Credit is allowed for tax paid to Canadian provinces (but not to Canada itself). Child tax credit allowed, but only for children over 4; it is usually 33% of the federal tax credit for those children. 30% of federal earned income credit allowed as state credit, and another 5% in New York City.
- Pennsylvania PA law allows deductions for medical and health savings account contributions, and IRC Section 529 tuition account program contributions (not IRA or 401(k) contributions). There is no standard deduction or personal exemption. There are 8 classes of income, taxed at different rates (PA Tax Compendium). Capital losses may not be deducted against capital gain distributions from mutual funds, only against actual capital gains, and may not be carried over from previous years. Social Security is excluded. Retirement plans withdrawals, pensions, and IRAs are not taxed if withdrawn after meeting the age requirements; otherwise, any net gains (such as withdrawals from an IRA before 59-1/2) are taxed. Credit for taxes paid to a foreign country, computed as for credit to taxes paid to another state. (PA PIT Guide - Chapter 7: Gross Compensation contains detailed tables of what's included, not included.)
- Virginia Social Security and Tier 1 Railroad Retirement are not taxed. There is an unusually large age deduction of $12,000 for taxpayers 65 or over; for taxpayers born in 1939 or later, this deduction is phased out by $1 for every $1 of income over $50,000 single/$75,000 married. You must use the standard or itemized deduction for Virginia according to which one you used on the federal return. $300 per person for a family with income below the poverty line, or 20% of the federal earned income credit, is allowed as a state credit, but this credit is non-refundable.
- ↑ 1.0 1.1 1.2 State Individual Income Tax Rates, from the Federation of Tax Administrators
- ↑ State and local income taxes are deductible within limitations (Act 97, Session Laws of Hawaii 2011). Reference: Alphabetical List of Forms Form N-11 Ins, page 17.
- ↑ 2010 PA Personal Income Tax Return Instructions and NJ Income Tax - PA/NJ Reciprocal Income Tax Agreement
- ↑ It is not mandatory for an employer to withhold out of state taxes for non-residents. Is there any thing I can do if my reciprocal state employer refuses to withhold PA Personal Income Tax?
- ↑ Minnesota publication: Use Tax Collection on Income Tax Returns in Other States
- Vanguard State-Specific Tax Information
- Vanguard US Government Obligations Information
- Retirement Living's guide to taxes by state
- State Individual Income Tax Rates, from the Federation of Tax Administrators
- State Comparisons, from the Federation of Tax Administrators. Includes numerous summary tables for state-by-state comparison of taxes, revenue, burdens, and other topics such as a list of State Sales Tax Holidays.
- Individual Income Tax Provisions in the States, from the Wisconsin Legislative Fiscal Bureau; includes summaries of the major differences between taxes in all states with an income tax. July, 2012.
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