Tax Definitions

If you plan to move to another state when you retire, examine the tax burden you’ll face when you arrive. State taxes are increasingly important to everyone, but retirees have extra cause for concern since their income may be fixed.

Many people planning to retire use the presence or absence of a state income tax as a litmus test for a retirement destination. This is a serious miscalculation since higher sales and property taxes can more than offset the lack of a state income tax. The lack of a state income tax doesn’t necessarily ensure a low total tax burden.

States raise revenue in many ways including sales taxes, excise taxes, license taxes, income taxes, intangible taxes, property taxes, estate taxes and inheritance taxes. Depending on where you live, you may end up paying all of them or just a few.

This section of our Web site provides you with information on state income taxes, sales and fuel taxes, taxes on retirement income, property taxes and inheritance and estate taxes. as well as sales and fuel taxes. It is intended to give you some insight into which states may offer a lower cost of living. To check out the state where you want to retire, just select from the state menu above.

All states except Alaska, Delaware, Montana, New Hampshire and Oregon, collect sales taxes. Some have a single rate throughout the state though most permit local city and county additions to the base tax rate. Those states with a single rate include Connecticut, Hawaii, Indiana, Kentucky, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, Rhode Island, Vermont, Virginia, and West Virginia.

States with the highest sales tax are: California (9.25%), Indiana (7%), Mississippi (7%), New Jersey (7%), Rhode Island (7%), Tennessee (7%), Nevada (6.85%), Washington (6.5%) and Illinois (6.25%).

Most states exempt prescription drugs from sales taxes. Some also exempt food and clothing purchases and a few also exempt non-prescription drugs.

Every state collects excise taxes on gasoline, diesel fuel and gasohol. The figures shown for each state reflect only the amounts controlled by the states and do not include additional taxes imposed on motor carriers. However, they do include other taxes paid at the pump by consumers. Where applicable they include sales taxes, gross receipts taxes, oil inspection fees, underground storage tank fees and other miscellaneous environmental fees. They do not include the federal excise tax which is 18.4 cents for gasoline and 24.4 cents for diesel fuel.

Nine states permit cities or counties to impose a local tax on fuel. Taxes in some states can also vary based on the wholesale price which is adjusted quarterly.

Several states are continuing to raise excise taxes on cigarettes and other tobacco products in order to increase revenue. The rates shown do not include the federal cigarette tax of $1.01 a pack. New York City is the most expensive place to buy cigarettes ($4.25). The top 12 states with the highest state tax on cigarettes are: Rhode Island ($3.46), New York ($2.75), New Jersey ($2.70), Hawaii ($2.60), Wisconsin ($2.52), Massachusetts ($2.51), Vermont ($2.24), Washington ($2.025, tied for ninth place are: Alaska ($2.00), Arizona ($2.00), Connecticut ($2.00), District of Columbia ($2.00) Maine ($2.00), Maryland ($2.00), and Michigan ($2.00).Tied for ninth place are: Alaska ($2.00), Arizona ($2.00), Connecticut ($2.00), District of Columbia ($2.00), Maine ($2.00), Maryland ($2.00), and Michigan ($2.00). Counties and cities may impose an additional tax ranging from 1 cent to $2.00 on a pack of cigarettes. About 82% of what consumers pay for a pack of cigarettes (average cost $5.11 – including statewide sales taxes but not local cigarette or sales taxes) ends up going to the government in taxes and other payments rather than for the cigarettes.

A total of 41 states impose income taxes. New Hampshire and Tennessee apply it only to income from interest and dividends. Seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) do not tax personal income. Of the 41 with a broad-based income tax, 35 base the taxes on federal returns, typically taking a portion of what you pay the IRS or using your federal adjusted gross income or taxable income as the starting point.

Most states specify amounts for taxpayers and each of their dependents that can be used as an offset in determining taxable income. Most also specify the amounts that persons 65 or older can deduct.

Most states treat health care expenses as having already been deducted from federal returns. Two states (North Dakota and Oregon) allow full deductions while Indiana doesn’t permit itemized deductions on state taxes.

Only nine of the 41 states with broad-based income taxes permit taxpayers to deduct some or all of their federal income taxes. This is an advantage if you are deciding between two states with similar rate structures but only one allows you to deduct. The latter would give you a lower effective tax rate. The states are Alabama, Iowa, Louisiana, Missouri, Montana, North Dakota, Oklahoma, Oregon and Utah.

Under federal law, taxpayers may be required to include a portion of their Social Security benefits in their taxable adjusted gross income (AGI). Most states begin the calculation of state personal income tax liability with federal AGI, or federal taxable income. In those states, the portion of Social Security benefits subject to personal income tax is subject to state personal income tax unless state law allows taxpayers to subtract the federally taxed portion of their benefits from their federal AGI in the computation of their state AGI.

Many states exclude Social Security retirement benefits from state income taxes. The District of Columbia and 27 states with income taxes provide a full exclusion for Social Security benefits — Alabama, Arizona, Arkansas, California, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia and Wisconsin.

The remaining 14 states with broad-based income taxes tax Social Security to some extent:

• Minnesota, Nebraska, North Dakota, Rhode Island, Vermont and West Virginia tax Social Security income to the extent it is taxed by the federal government.
• Connecticut, Iowa, Kansas, Missouri and Montana tax Social Security income above an income floor. Iowa will gradually phase out its Social Security tax levy from 2008 through 2014. Missouri will phase out its Social Security tax levy by 2010. Kansas residents can exclude Social Security income if their adjusted gross income is less than $75,000.
• Colorado, New Mexico and Utah require that federally untaxed Social Security benefits be added back to federal AGI to calculate the base against which their broad age-determined income exclusions apply.

States are prohibited from taxing benefits of U.S. military retirees if they exempt the pensions of state and local government retirees. Most states that impose an income tax exempt at least part of pension income from taxable income. Different types of pension income (private, military, federal civil service, and state or local government) are often treated differently for tax purposes.

States are generally free from federal control in deciding how to tax pensions, but some limits apply. State tax policy cannot discriminate against federal civil service pensions. Ten states exclude all federal, state and local pension income from taxation. These include Alabama, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Mississippi, New York and Pennsylvania. Among these 10 states, only Kansas taxes any Social Security income, but only to the extent it is subject to federal taxation. These 10 states differ on the taxation of retirement income from private-sector sources. Kansas and Massachusetts do not exclude any private-sector retirement income, but most of the others allow a fairly broad exclusion. In tax year 2008 Kansas residents with an adjusted gross income of less than $75,000 may exclude Social Security income from state taxes. Pennsylvania allows a full exclusion. Alabama excludes income from defined benefit plans. Hawaii excludes income from contributory plans. Illinois and Mississippi exclude income from qualified retirement plans. Louisiana, Michigan and New York cap the private-sector exclusion at $6,000, $34,920 and $20,000, respectively.

Five states (California, Connecticut, Nebraska, Rhode Island, and Vermont) allow no exemptions or tax credits for pension and other retirement income that is counted in federal adjusted gross income. Most in-state government pensions are taxed the same as out-of-state government pensions. However, Arizona, Idaho, Kansas, Louisiana, New York, and Oklahoma provide greater tax relief plans than they do for out-of-state government pension plans. The District of Columbia also provides greater tax relief for DC government pensions than for state government pensions.

Three states (New Jersey, Massachusetts, and Pennsylvania) do not allow IRA contributions to be deducted from taxable income. Of the three, only Pennsylvania does not tax IRA earnings of taxpayers age 59 years or older, since earnings are treated like pension income, which is tax exempt.

Some states provide special tax benefits to military retirees. Others simply follow the federal tax rules. The states that do not tax retired military pay are: Alabama, Alaska, Florida, Hawaii, Illinois, Kansas, Kentucky*, Louisiana, Massachusetts, Michigan, Mississippi*, Missouri*, Nevada, New Hampshire, New Jersey, New York, North Carolina*, Ohio, Oregon*, Pennsylvania, South Dakota, Tennessee, Texas, Washington, Wisconsin and Wyoming.(*With conditions)

Taxes on land and the buildings on it are the biggest source of revenue for local governments. They are not imposed by states but by the tens of thousands of cities, townships, counties, school districts and other assessing jurisdictions.

The state’s role is to specify the maximum rate on the market value of the property, or a percentage of it, as the legal standard for the local assessors to follow. The local assessor determines the value to be taxed. You can’t escape property taxes in any state. But you can find significantly low rates in certain parts of the country.

Most states give residents over a certain age a break on their property taxes. With some taxes, you’ll need a relatively low income to qualify. Forty states provide either property tax credits or homestead exemptions that limit the value of assessed property subject to tax.

There may be other tax breaks available, depending on where you live. All 50 states offer some type of property tax relief program, such as freezes that will lock in the assessed value of your property once you reach a certain age, or deferral of taxes until the homeowner moves or dies. They ultimately have to be paid. In addition, counties and municipalities often have their own property tax relief plans.

Retirees with low incomes and high housing costs may face property tax bills that are higher than they can manage. Some states target property tax relief to those homeowners bearing the greatest burden. Property tax reform that takes into account a homeowner’s ability to pay, such as a so-called “property tax circuit breaker,” can better protect low-income homeowners from rising property taxes that accompany rising property values. Targeted property tax relief avoids sharp reductions in funding for locally provided public services and inequities based solely on date of purchase.

• A property tax circuit breaker prevents property taxes from “overloading” a taxpayer. Under a typical circuit breaker, the state sets a maximum percentage of income that an eligible family can be expected to pay in property taxes. If property taxes exceed this limit, the state then provides a rebate or credit to the taxpayer.
• Currently, of the 31 states and the District of Columbia with circuit breakers for homeowners, only six and the District of Columbia permit all households to participate in the program without regard to age.

Other property tax relief strategies that may be used to target property tax relief include homestead exemptions which exempt a certain amount of a home’s value from taxation, credits to rebate a certain percentage of taxes paid, and deferral programs to allow low-income elderly homeowners to defer payment of property taxes until property is sold.

New data released by the Census Bureau shows that over a three-year period (2005 – 2007) taxes paid by homeowners in New York and New Jersey counties were the highest while several Louisiana parishes paid the least. This information is based on the data from the Census Bureau’s American Community Survey which now includes three-year averages for places where the population is greater than 20,000.

The data below has been organized and presented by the Washington, D.C. – based Tax Foundation. The top five most expensive counties to live in based on the average median real estate taxes paid over the last three years are Westchester County NY ($7,908), Nassau County NY ($7,726), Hunterdon County NJ, ($7,708), Bergen County NJ ($7,370), and Somerset County NJ ($7,201). The five least expensive counties were in Louisiana: Vernon Parish ($115), Allen Parish ($116), Franklin Parish ($117), Richland Parish ($118) and Assumption Parish ($123).

Looking at average median real estate taxes paid from 2005 – 2007 as a percentage of median home value, the following New York counties are the top five: Orleans (3.05%), Niagara (2.90%), Allegany (2.87%), Montgomery (2.86%), and Monroe (2.84%). The counties with the lowest taxes as a percentage of median home value are in Louisiana: St. John the Baptist Parish (0.122%), Ascension Parish (0.134%), Tangipahoe Parish (0.139%), West Baton Rouge Parish (0.145%), and St. James Parish (0.145%).

Click here for a chart of real estate taxes paid on owner-occupied housing for each of the more than 1,800 counties with populations greater than 20,000 for the years 2005, 2006 and 2007. This table also shows the rankings of median real estate taxes paid by dollar amount. Click here for rankings by median real estate taxes as a percentage of the median home value and as a percentage of the median income for household owning units.

An inheritance tax is an assessment made on the portion of an estate received by an individual. It differs from an estate tax which is a tax levied on an entire estate before it is distributed to individuals. It is strictly a state tax. Eleven states still collect an inheritance tax. They are: Connecticut, Indiana, Iowa, Kansas, Kentucky, Maryland, Nebraska, New Jersey, Oregon, Pennsylvania and Tennessee. In all states, transfers of assets to a spouse are exempt from the tax. In some states, transfers to children and close relatives are also exempt.

Estate-tax changes appear inevitable. Under current law, the basic federal estate-tax exemption for 2009 is $3.5 million, and the top estate-tax rate is 45%. (Transfers between spouses typically are tax-free.) In 2010 the tax is scheduled to disappear entirely — only to reappear in 2011 with a $1 million exemption and a top rate of 55% on the largest estates. But don’t bet on a total repeal. While that was the Bush administration’s oft-stated dream, President Obama has said he is opposed to that idea. Instead, he said during the presidential campaign that he favors extending this year’s $3.5 million per-person exemption level and the 45% top rate into future years. Another factor to consider: Many states impose their own death-related taxes.

In most states, estate and inheritance taxes are designed in such a way that states face either a full or partial loss of estate tax revenues as this credit is phased out. States can avert this loss of revenue by “decoupling.” Decoupling means protecting the relevant parts of their tax code from the changes in the federal tax code, in most cases by remaining linked to federal law as it existed prior to the change.

Seventeen states and the District of Columbia have retained their estate taxes after the federal changes. Of these, 15 states — Illinois, Kansas, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, North Carolina, Ohio, Oregon, Rhode Island, Vermont, Virginia, and Wisconsin — and the District of Columbia decoupled from the federal changes. Two states — Nebraska and Washington — retained their tax by enacting similar but separate estate taxes.

Of these, 12 states acted to decouple from the federal changes. Illinois, Maine, Maryland, Massachusetts, New Jersey, Rhode Island, and Vermont enacted legislation linking their estate taxes to the federal estate tax as in effect before the 2001 tax bill. Minnesota, which passes a tax conformity package each year, explicitly elected not to change its estate tax to conform to the federal changes. North Carolina elected to decouple at least through 2005, and Wisconsin has decoupled through 2007. Nebraska decoupled by creating a separate state estate tax on estates that exceed $1 million based on the federal law before the 2001 changes. In 2005, Washington enacted a separate tax with a somewhat different rate structure that applies to estates that exceed $2 million after the state’s original decoupling was nullified in court.

In addition, five states and the District of Columbia will remain decoupled unless they take legislative action. In five states — Kansas, New York, Ohio, Oregon, and Virginia — and the District of Columbia, estate tax laws are written in such a way that the state will not conform to the federal changes unless it takes legislative action.

If all other things are equal, a state with a lower burden is a more attractive place to retire than a state with a higher one. To get a true sense of which state is less expensive, you need to look at state and local tax burdens. Only then do the low tax states stand out.

It is estimated by the Tax Foundation that the nation as a whole will pay on average 9.7% of its income in state and local taxes in 2008, down from 9.9% in 2007 primarily because income grew faster than tax collections between 2007 and 2008.

New Jersey residents paid 11.8%, topping the charts. New Yorkers were close behind, paying 11.7%, and Connecticut was third at 11.1%. The top 10 were rounded out by Maryland (10.8%), Hawaii (10.6%), California (10.5%), Ohio (10.4%). Vermont (10.3%), Wisconsin (10.2%) and Rhode Island (10.2%).

Alaskans pay the least, 6.4 percent in 2008, but Nevada is close at 6.6 percent. In four states the residents pay between 7 and 8 percent of their income in state and local taxes: Wyoming (7.0%), Florida (7.4%), New Hampshire (7.6%) and South Dakota (7.9%). Four other states round out the bottom 10: Tennessee (8.3%), Texas (8.4%), Louisiana (8.4%) and Arizona (8.5%).

Individual state tax and revenue departments, State Tax Handbook (2009); published by CCH Inc., Federation of Tax Administrators, The Tax Foundation, National Conference of State Legislatures

Updated August 2009; based on available data.