Unless you live in Alaska, Florida, Nevada, South Dakota, Texas, Washington or Wyoming, chances are you are aware of state income taxes. Much like how the federal government collects a federal income tax on your wages and other income, local and state governments levy a similar, though smaller, state income tax on your wages and other income. Those who happen to live in Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming are lucky because those states don’t have an income tax. New Hampshire and Tennessee only levy an tax on dividend and interest income.
In many states, the income tax works just like at the federal level with different tiers and different marginal rates. Only seven states levy a flat rate (Colorado, Illinois, Indiana, Massachusetts, Michigan, Pennsylvania, Utah), most prefer a graduated scale. In my home state of Maryland, the tiers are (for single filers):
- 2.00% for $0 to $1,000
- 3.00% for $1,000 to $2,000
- 4.00% for $2,000 to $3,000
- 4.75% for $3,000 to $150,000
- 5.00% for $150,000 to $300,000
- 5.25% for $300,000 to $500,000
- 5.50% for $500,000 to $1,000,000
- 6.25% for $1,000,000+
State income taxes are important because if you live in a state with high state income taxes, you may want to consider investments in municipal bonds. Municipal bonds are a special class of investments whose interest is exempt from state and local taxes in the issuing jurisdiction. Munis, as they’re called, are issued by a state or local government to raise money and the tax break is an incentive for investors.
State income taxes are tax deductible on your federal income tax return if you itemize your deductions on a Schedule A. State income taxes fall into the category of deductible nonbusiness taxes, like personal property taxes you pay if you own your own home. For most taxpayers, you won’t need to worry about this when you file your taxes because the state income taxes you’ve paid will be reflected on your W-2. For those who make estimated payments, it’s important that you keep track of those payments so you can claim the proper amount in state income taxes paid.