There are a total of seven states with no income tax. An additional two states only tax dividend and interest income. However, regardless of whether they live in a state that does not tax income, every U.S. resident must still pay the federal government's income tax.
Federal vs. State Income
Although a state may not charge income tax, the federal government does. Living in a state with no income tax does not excuse an individual from filing a federal income tax return or paying federal income taxes. Taxpayers must file both a federal and state return and remit any required payments by the Internal Revenue Service's (IRS) yearly deadline or risk being fined.
List of States
Seven states do not tax residents' income: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. In these states, earned income is not taxed either at the time of payment or at tax time. An additional two states, New Hampshire and Tennessee, only tax interest and dividend income. Residents of these states pay taxes on any income received from investments, but not on their salary or wages.
- Alaska: Not only does this state not charge an income tax, but it rewards residents with an annual dividend check from its oil revenue fund. Alaska also does not charge taxes on inheritances or estates, no matter how large.
- Florida: The lack of income tax in this state was designed to accommodate the state's large retirement and seasonal population. Until 2007, Florida taxed investment income, but no longer does so. The state does not have an inheritance tax, but does have a limited estate tax.
- Nevada: Nevada residents are not taxed on their incomes, inheritances or estates.
- South Dakota: Residents of South Dakota not only avoid taxes on their incomes, but also on any inheritances and their estates.
- Texas: The Lone Star State keeps its hands off its residents' incomes. It also does not tax inheritances or estates.
- Washington: Although their income escapes taxes, the same might not be true for a Washington resident's estate. Estates valued at two million dollars or larger are subject to state taxation. However, Washington does not charge inheritance taxes.
- Wyoming: The state's statutes automatically excludes yearly earnings and inheritances from taxes, but isn't so clear when it comes to estates. According to its laws, estates can be taxed if justified by authorities. What is considered "justified," though, isn't defined.
- New Hampshire: Salaries and wages escape the tax authority's hand, but not interest or dividend income. Single taxpayers who earned more than $2,400 in the previous year in interest and dividends, and joint taxpayers who earned more than $4,800 must pay taxes on those earnings. As of 2011, the state charged five percent taxes on interest and dividend income exceeding the threshold. New Hampshire does not tax estates or inheritances.
- Tennessee: The state taxes interest and dividend income, but excludes the first $1,200 for single taxpayers and $2, 500 for joint taxpayers from being taxed. The state taxes inheritances and estates based on their size.
Definition of Income
While every state's definition considers salaries and wages earned in a year as income, the treatment of investments, dividends, rental property payments and other assets which generate money differ. Therefore, despite the claim of being "income-tax free," these states might tax the money earned by its residents through other means.
Interest and dividend earnings are most commonly excluded from the protection of being considered income. Although earnings from these sources must exceed a threshold before becoming subject to taxes, they are still taxed. Money earned from stocks, bonds, investment funds, capital gain distributions or insurance policy payments are usually considered interest or dividend income.
Inheritances and estates are also sometimes excluded. An inheritance is money or property received as a result of the death of another individual. Estates are the assets an individual owns at the time of their death, including any real and personal property, investments and cash. Proceeds from life insurance policies are not considered part of an estate.
While residents of states with no income tax may escape liability on their yearly earnings, they may find that they owe money on their other assets. Check with your state's department of revenue or taxing authority to determine the rules that apply to you.
Your Income Tax Obligations
Many residents make the claim that it is great to live in a state with no income tax, but that doesn't mean these residents owe nothing. Moreover, to make up for the lack of revenue from not taxing incomes, residents might find themselves paying higher sales or property tax rates. Overall, however, not paying state income taxes often means that at the end of the year they have more money in their wallets.