Federal taxes get most of the attention, but state income taxes can add 0% to 13.3% on top of your federal bill depending on where you live. For a high-income earner, the difference between living in Texas (0% state income tax) and California (13.3% top rate) can be over $100,000 per year in state taxes alone.
State income taxes affect where people live, where businesses incorporate, where retirees relocate, and how high-income earners structure their finances. Yet most people pay whatever their state charges without understanding the rules, the alternatives, or the legal strategies to minimize their state tax burden.
This guide covers how state income taxes work, compares all 50 states, and explains the strategies CPAs use to reduce state tax legally.
States with No Income Tax
Nine states impose no state income tax on wages and salary:
- Alaska
- Florida
- Nevada
- New Hampshire (taxes interest and dividends only — being phased out)
- South Dakota
- Tennessee (eliminated its tax on interest and dividends in 2021)
- Texas
- Washington
- Wyoming
Living in a no-income-tax state saves a significant amount, especially for high earners. A person earning $300,000 in California pays approximately $22,000 in state income tax. The same income in Texas: $0.
However, no-income-tax states often make up revenue through other means — higher property taxes (Texas), higher sales taxes (Tennessee, Washington), or natural resource revenue (Alaska). The total tax burden depends on your complete financial picture, not just income tax.
Washington also imposes a 7% tax on capital gains exceeding $270,000 (upheld by the state supreme court as an "excise tax"). So while it has no income tax, very high capital gains are taxed.
How State Income Taxes Work
States use one of three systems:
Flat tax states charge the same rate on all income:
- Arizona: 2.5%
- Colorado: 4.4%
- Georgia: 5.49% (transitioning to flat rate)
- Idaho: 5.8%
- Illinois: 4.95%
- Indiana: 3.05%
- Iowa: 3.8% (phasing down)
- Kentucky: 4.0%
- Michigan: 4.25%
- Mississippi: 4.7% (phasing down)
- New Hampshire: 3% (interest/dividends only, phasing out)
- North Carolina: 4.5% (phasing down)
- Pennsylvania: 3.07%
- Utah: 4.65%
Progressive tax states have brackets similar to the federal system, where higher income is taxed at higher rates:
- California: 1% to 13.3% (highest in the nation)
- New York: 4% to 10.9%
- New Jersey: 1.4% to 10.75%
- Oregon: 4.75% to 9.9%
- Minnesota: 5.35% to 9.85%
- Hawaii: 1.4% to 11%
- And many others
The rates and brackets vary significantly. Some states have many brackets (California has 10), while others have just a few.
City and local income taxes add another layer in some areas:
- New York City: up to 3.876% on top of New York State tax
- Yonkers, NY: 16.75% surcharge on state tax
- Many Ohio cities: 1-3% municipal income tax
- Philadelphia: 3.75% (residents)
- Some Maryland counties: 2.25-3.2% local tax
- Detroit, MI: 2.4%
- Portland, OR: multiple local taxes adding 1-3%+
A high-income New York City resident faces a combined state and local rate of nearly 15% — on top of federal taxes.
State Tax on Different Income Types
Not all states treat all income the same:
Wages and salary: Taxed by the state where you work (not necessarily where you live). Most states have withholding requirements for employers.
Business income: Pass-through business income is typically taxed in the state where the business operates and/or where the owner resides. Multi-state businesses may owe tax in multiple states.
Retirement income: Treatment varies dramatically:
- Some states fully exempt Social Security (most do)
- Some states exempt pension income or provide a partial exclusion
- Some states exempt all retirement income (Illinois, Mississippi, Pennsylvania)
- Some states tax all retirement income (California, Minnesota, Vermont)
For retirees choosing where to live, state tax treatment of retirement income is one of the most impactful financial factors.
Capital gains: Most states tax capital gains as ordinary income. A few exceptions — New Hampshire doesn't tax capital gains (since it only taxes interest and dividends, being phased out), and Washington taxes capital gains above $270,000 at 7% despite having no income tax.
Investment income: Generally taxed at the same rate as other income. No state has a separate preferential rate for long-term capital gains like the federal system.
Military pay: Many states exempt active-duty military pay from state income tax, especially for service members stationed elsewhere.
The SALT Deduction Cap
State and local taxes (SALT) are deductible on your federal return if you itemize — but only up to $10,000 ($5,000 married filing separately).
This cap, introduced by the Tax Cuts and Jobs Act of 2017, significantly impacts taxpayers in high-tax states. A homeowner in New Jersey paying $15,000 in property taxes and $8,000 in state income tax has $23,000 in SALT — but can only deduct $10,000 federally. The remaining $13,000 generates no federal tax benefit.
The SALT cap has been a major political issue, particularly in high-tax states like New York, New Jersey, California, and Connecticut. As of this writing, the cap remains in place but has been a subject of ongoing legislative negotiation.
SALT Cap Workaround for Business Owners
Many states now offer a pass-through entity tax (PTET) election that effectively bypasses the $10,000 SALT cap.
How it works: Instead of the business owner paying state income tax on their pass-through income individually (subject to the $10,000 cap), the business entity itself pays state tax on the income. Entity-level state tax is deductible as a business expense — not subject to the SALT cap. The owner receives a credit or deduction on their state return for the tax paid at the entity level.
The IRS has approved this structure. Over 30 states now offer some version of the PTET election.
The savings can be substantial. A business owner in New York with $500,000 in pass-through income might save $15,000-$25,000 in federal taxes through the PTET election.
If you own a pass-through business in a high-tax state and your CPA isn't utilizing the PTET election, you're likely overpaying.
Multi-State Taxation
If you live in one state and work in another, or if you earn income in multiple states, multi-state taxation applies.
The general rule: You owe state tax to the state where you earn the income. You also owe tax to your resident state on all income, but you receive a credit for taxes paid to other states (to avoid double taxation).
Example: You live in New Jersey but work in New York. You owe New York tax on your New York wages. New Jersey also taxes your worldwide income — but gives you a credit for the tax paid to New York. If New York's rate is higher than New Jersey's, you effectively pay the New York rate. If New Jersey's rate is higher, you pay the difference to New Jersey.
Remote work complications: The pandemic created significant multi-state tax issues for remote workers. Some states (New York, Connecticut, Nebraska, Delaware, Pennsylvania) have "convenience of the employer" rules — if you work remotely for an employer located in that state, the state may tax your income even though you're not physically present.
If you work remotely for an employer in a different state, check both states' rules. You may need to file returns in both states.
Business nexus: If your business has physical presence (office, warehouse, employees, inventory) or economic nexus (meeting revenue or transaction thresholds) in a state, the business may owe tax in that state. Multi-state business taxation is one of the most complex areas of state tax law.
Strategies to Minimize State Income Tax
Domicile planning. If you split time between a high-tax state and a no-tax state, establishing domicile in the no-tax state eliminates state income tax. But the high-tax state will fight to keep you as a resident.
To prove you've changed domicile:
- Physically move to the new state
- Spend the majority of your time there (183+ days is a common threshold)
- Change your driver's license, voter registration, and vehicle registration
- Use the new state's address for bank accounts, investment accounts, and tax returns
- Join local organizations, register at local doctors, and establish community ties
- Sell or rent out your home in the old state (or at minimum, stop treating it as your primary residence)
High-tax states (New York, California, New Jersey) audit domicile changes aggressively. They examine credit card records, cell phone pings, social media, travel records, and any evidence that suggests you're still a resident. The audit defense can be expensive, so the move must be genuine.
Entity structuring. For business owners, the state where your entity is formed and operates affects which states can tax the income. Strategic entity placement can reduce state tax exposure, but substance requirements must be met — you can't just form an LLC in Delaware or Wyoming and claim the income is earned there if you operate in California.
PTET election. As described above, the pass-through entity tax election can save business owners in high-tax states significant federal taxes by circumventing the SALT cap.
Timing income. If you're planning a move from a high-tax state to a low-tax state, timing the recognition of income (bonuses, stock option exercises, business distributions, asset sales) to occur after the move can save significant state tax.
Retirement location. Choosing to retire in a state that doesn't tax retirement income (or has no income tax) eliminates state tax on Social Security, pensions, and retirement account withdrawals. This can save $5,000-$30,000+ per year for retirees with substantial retirement income.
Charitable strategies. In states that offer state tax deductions for charitable contributions above what federal law provides, coordinating charitable giving with state tax benefits adds value.
State-specific credits and incentives. Many states offer credits for historic preservation, brownfield development, angel investment, film production, renewable energy, job creation, and other activities. These credits can be worth thousands to tens of thousands of dollars.
State Tax and Retirement Planning
State tax treatment of retirement income varies widely:
States that don't tax any retirement income: Alaska, Florida, Illinois, Mississippi, Nevada, New Hampshire, Pennsylvania, South Dakota, Tennessee, Texas, Washington, Wyoming.
States that exempt Social Security but tax other retirement income: Most states. Some provide partial exemptions for pensions or retirement account withdrawals.
States that tax Social Security: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont, West Virginia — though most of these provide partial exemptions based on income.
For someone with $80,000 in retirement income, the difference between retiring in Illinois (0% on retirement income) vs. California (up to 9.3% on that income) is approximately $5,000-$7,000 per year. Over 25 years of retirement, that's $125,000-$175,000.
How a CPA Helps with State Tax
State tax planning is highly specialized. A CPA who knows state tax:
Identifies multi-state obligations. Determines which states you need to file in and ensures you're not overpaying through incorrect credits or missed exemptions.
Utilizes the PTET election. For business owners in high-tax states, this single strategy can save more than the CPA's annual fee.
Plans domicile changes. Structures a genuine move to minimize state tax while avoiding audit risks.
Coordinates retirement relocations. Models the total tax impact of different retirement destinations, including state income tax, property tax, sales tax, and estate tax.
Navigates state-specific rules. Each state has unique deductions, credits, exemptions, and quirks. A CPA who practices in your state knows these details.
State taxes are too often an afterthought. For high-income earners and business owners, they represent one of the largest areas of potential savings.
Find a CPA who specializes in state tax planning at ListMyCpa.com. Search by state and city to find someone who knows your state's tax code inside and out.