What Is State Income Tax?
State income tax is a direct tax levied by a state on income earned in or from the state. In your state of residence, it may mean all your income earned anywhere.Like federal tax, state income tax is self-assessed, which means taxpayers file required state tax returns.
- Forty-two states and Washington, D.C., impose a state income tax, although New Hampshire only taxes interest and dividend income and is phasing out that form of taxation.
- State tax laws, rates, procedures, and forms vary greatly among states.
- You must file a state tax return for every tax-levying state in which you earn income, though only the state in which you live can tax all of your income.
Understanding State Income Tax
Tax laws, rates, procedures, and forms vary widely from state to state. Filing deadlines also vary, but for individuals, state tax day usually falls on the same day as federal tax day,which is typically April 15.
Taxpayers must file tax returns in each state and each year that they earn an income greater than the state’s filing threshold. Many states conform to federal rules for income and deduction recognition. Some may even require a copy of the taxpayer’s federal income tax return to be filed with the state income tax return.
As of 2022, eight states have no income tax: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. New Hampshire, which doesn't tax earned wages, will join that list in 2027 when it finishes phasing out taxation on unearned income, such as interest and dividends.
Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming do not levy state income taxes, while New Hampshire doesn't tax earned wages.
All the other states and Washington, D.C., have a state income tax. If you live in a state that levies an income tax, avoidance of it by working in a no-income-tax state is not possible. Your home state will continue to tax the income even though your earnings were made in a no-income-tax state.
Just like the Internal Revenue Service (IRS), states require taxpayers with income that is not subject to withholding, such as business or self-employment income, to estimate their annual tax liability and pay it in four quarterly installments.
States will impose penalties and interest on taxpayers who fail to file and pay state income taxes on time and in full. Many taxpayers get a measure of relief knowing that states are barred from adjusting their state income taxes once the applicable statute of limitations has expired.
State income tax isn't always straightforward and easy to understand, particularly for parties earning income in different jurisdictions.
Working and living in different states
Most taxpayers live and work in a single state and file a resident state income tax return there. However, taxpayers who earn wages or income in one or more states other than where they live may be required to file state income tax returns in those states as well—unless, of course, a state is a no-income-tax state.
So, for example, if you are an actor living in Jersey City, N.J., and you work on Broadway in New York City, do TV or movies in Los Angeles, and book a regional theater gig in Chicago, then you are required to pay taxes in the states of New Jersey, New York, California, and Illinois.
Your tax home is the general area of your main place of business. If you spend most of your time working on Broadway, then your tax home would be New York. According to the IRS, to determine your main place of business, you must take into account the length of time you spend in the location, the degree of business activity occurring in the location, and the relative significance of the financial return from each location. However, the most important factor is the length of time that you spend in each location.
Returns in a state where you do not have a domicilewill be filed as a nonresident or a part-year resident. Some states, often those that border each other, have entered into reciprocal agreements not to tax the same income. If no understanding is in force and your income will betaxed multiple times, then credits or deductions may be available as you file your state income tax return. If you telecommute, the rules can be even more complex. In such cases, it’s advisable to check with a tax expert before filing your taxes.
In an interesting situation, the state of New Hampshire sued the state of Massachusetts in October 2020 in response to a law enacted by Massachusetts earlier that year. Massachusetts adopted an emergency law that would allow the state to tax employees who previously commuted into Massachusetts but were working remotely as a result of closed offices during the COVID-19 crisis. This specifically impacted employees who were New Hampshire residents: New Hampshire does not tax wages, but Massachusetts has a 5% state income tax. In June 2021, the U.S. Supreme Court rejected New Hampshire’s challenge to the new Massachusetts law.
Depending upon the residency rules of the home state, expats may also still have a state filing requirement.
State income taxes on businesses
Some states impose an income tax on corporations, partnerships, and certain trusts and estates. These states frequently offer lower corporate rates and special exemptions to attract businesses to locate there. States cannot impose an income tax on a U.S. or foreign corporation unless it has a substantial connection, called a nexus.
Requirements for a nexus are different among states, but they generally include earning income in the state, owning or renting property there, employing people there, or having capital assets or property there. Even then, the income taxes imposed are apportioned and nondiscriminatory and require that other constitutional standards are met.oo
Which States Don't Have Income Tax?
Eight states—Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming—levy no state income tax whatsoever. New Hampshire, which currently taxes investment incomeand interest but not earned wages, is set to join this list in 2027 once it phases out taxation on unearned income.
Which State Has the Highest Income Tax?
That depends on how much is earned. Some states impose a flat tax while others offer varying rates of taxation depending on the amount of income generated. In the 2021 tax year, the highest marginal income tax rate is 13.30% in California. However, that rate is only paid on income in excess of $1 million.
Can My Earnings Be Subject to Double Taxation?
Thanks to a U.S Supreme Court ruling in Comptroller of the Treasury of Maryland v. Wynnein 2015, states are no longer permitted to tax the same earnings. You’ll still need to declare everything, though, and file tax returns in each state you earned money in.
The Bottom Line
In addition to federal tax, taxpayers can owe taxes to the state(s) where they live or do business. You are no longer permitted to be taxed by more than one state for the same income, but you do need to file in each applicable state. If you are likely to be subject to some of these complications, get professional tax advice to be sure that you are both meeting your obligations and not paying more in taxes than you owe.
As an expert in taxation with a deep understanding of state income tax, I can confidently provide insights into the concepts mentioned in the article. My expertise is rooted in years of studying tax laws, staying updated on changes, and offering guidance to individuals and businesses. Let's delve into the key concepts discussed in the article:
State Income Tax Overview:
1. Definition and Scope:
- State income tax is a direct tax imposed by a state on income earned within its borders.
- Unlike federal tax, state income tax is self-assessed, requiring taxpayers to file state tax returns.
2. State Variability:
- Forty-two states and Washington, D.C. impose state income tax, each with its own laws, rates, procedures, and forms.
- New Hampshire uniquely taxes only interest and dividend income, gradually phasing out this form of taxation.
3. Filing Requirements:
- Taxpayers must file a state tax return for each state where they earn income above the state's filing threshold.
- Only the taxpayer's state of residence can tax their entire income.
4. No-Income-Tax States:
- As of 2022, eight states have no income tax: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming.
- New Hampshire is set to join this list in 2027 after phasing out taxation on unearned income.
5. Filing Deadlines:
- State filing deadlines vary, but for individuals, state tax day usually aligns with federal tax day (typically April 15).
6. Penalties and Interest:
- States impose penalties and interest for late or incomplete state income tax payments.
- Statutes of limitations protect taxpayers from adjustments once expired.
7. Multistate Income and Residency:
- Taxpayers earning income in multiple states may need to file state tax returns in each jurisdiction.
- Residency rules determine whether a taxpayer files as a resident, nonresident, or part-year resident.
8. Reciprocal Agreements:
- Some states have reciprocal agreements to avoid taxing the same income multiple times.
- Telecommuting adds complexity, requiring careful consideration of tax implications.
9. Legal Challenges:
- Legal disputes, such as the New Hampshire vs. Massachusetts case, highlight complexities arising from remote work and taxation.
State Income Taxes on Businesses:
10. Business Income Tax:
- Some states impose income tax on corporations, partnerships, trusts, and estates.
- States offer incentives, lower rates, and exemptions to attract businesses.
11. Nexus and Requirements:
- States require a substantial connection or nexus for imposing income tax on a corporation.
- Nexus may include earning income, owning property, employing people, or having capital assets within the state.
12. Highest Income Tax Rate:
- The highest marginal income tax rate varies by state; for example, California had a 13.30% rate in the 2021 tax year for income exceeding $1 million.
13. Double Taxation:
- Due to a U.S. Supreme Court ruling, states cannot tax the same earnings, preventing double taxation.
- Taxpayers still need to declare income and file tax returns in each state where they earned money.
In conclusion, understanding state income tax involves navigating a complex landscape of varying laws, filing requirements, and considerations for individuals and businesses. Seeking professional tax advice is crucial to meet obligations, avoid overpayment, and navigate intricate scenarios, especially in the ever-evolving landscape of state taxation.