States With No Income Tax Explained

Written by
Amber Hobert
Published on
April 23, 2022
Table of Contents

Who is Exempt from Income Taxes?

Following the passage of the United States Constitution, the national government was given the ability to tax its inhabitants. Each state also obtained the ability to levy whatever taxes it wished, except for those prohibited by the United States Constitution as well as their state Constitution. Taxation, fees, plus licensing support these states' governments.

South Dakota and a few other states do not charge a personal income tax on a state-wide level. The sales tax in the region is also one of the lowest in the U.S. South Dakota's estimated average property tax rates, on the other hand, are higher than the nationwide average. South Dakota has no corporate income tax.

Around thirty-two states (including D.C.) have a progressive income tax in the remainder of the country, which means that higher-income earners pay a more significant proportion of their income than lesser earners. On the other hand, nine states have zero income tax, which means everybody is taxed at an equal rate irrespective of income status.

What Led to the Exemption of Income Tax in South Dakota?

South Dakota's economy was in a severe slump in the late 1970s, and Bill Janklow, the then Governor of South Dakota, was willing to go to nearly any length to bring in some revenue. He saw a chance to reduce the rules established by other jurisdictions.

Janklow supported passage of legislation to remove South Dakota's limit on interest rates. This attracted banks; for instance, Citibank opened a credit card center in Sioux Falls. Several states had similar laws, overturning previous policies against high rates. Under the federal banking rules a state had to formally invite a bank into their state, and South Dakota invited Citibank before other states.

Likely Benefits for Retirees Moving to South Dakota

Planning for retirement is crucial, but so is preserving money in retirement. Moving to a state that does not have an income tax is one option that can save money. This might imply no state tax on Social Security payments, pensions, life insurance, or even other forms of retirement income for seniors. If your earnings place you in the uppermost levels of not only the nation but of the globe, South Dakota is a viable destination.

This is because it has state-level regulations that allow trusts to continue in perpetuity, devoid of state income tax as well as capital gains taxes, and helped by court-sealed records.

Compared to its competitors, South Dakota's key businesses are banking as well as health care. South Dakota is perhaps the only state with a fully funded pension, an equitable budget as of 1889, and a state debt of around 3.1 percent of GDP (Gross Domestic Product). It also has minor unemployment levels in the U.S., at approximately 2.8 percent in December 2016.

What Exactly is Income Tax?

State income tax refers to the tax levied on earnings produced inside the state. It is comparable to federal income tax in that it pays state budgets instead of the federal government. The federal individual income tax contains seven tax rates that range from around 10% to 37%. The rates are applied to taxable income, adjusted gross income less than the standard deduction or permitted itemized deductions.

Therefore, any earnings up to the standard deduction (or itemized deductions) are taxed at around zero percent. The federal income tax levels generally are progressive, which means that as taxable income grows, it is taxed at a greater rate. Based on the taxpayer's filing situation, various tax rates are paid on income in different ranges (or categories).

Since 2020, the maximum tax rate (37%) applies to the taxable income of more than around $518,400 for solo filers. Tax timelines and rates differ for taxpayers submitting as heads of family or married persons submitting separate returns.

Capital gains, as well as dividends, are subject to a different taxation schedule. Yearly, tax brackets are updated for inflation. You are not supposed to declare an S.D. (Standard Deviation) State Income Tax Return because South Dakota does not collect personal income taxes.

How is it That South Dakota Has No Income Tax?

This should be unsurprising as tourism, unique taxes on gaming and mining, and a 4.6 percent sales tax account for most of the state's income. South Dakota taxpayers are not required to pay personal income taxes at state and local levels. Most of its revenue is generated through sales as well as property tax

Other States with No Income Tax

New Hampshire

Earned income is not taxed in New Hampshire, although dividends, as well as interest, are. The New Hampshire Senate accepted a bill to phase out the investment income tax by around 1% each year for the next five years, including full implementation by about 2027.

The state does not impose a state sales tax, but it does collect excise taxes, particularly alcohol taxes. In addition, its mean property tax rate of around 2.2% is the third highest in the U.S.

Alaska

Alaska does not have a state income or sales tax. Alaskans' overall state as well as local tax burden, comprising income, property, sales, and excise taxes, is only around 5.16 percent of individual income, the least of any of the 50 states. The Alaska Permanent Fund Corp. pays an annual payment to all its residents based on income and investment gains from mineral lease rentals plus royalties.

In 2020, the per-citizen dividend pay out was around $992. However, the living cost in Alaska is expensive, owing primarily to the state's isolated location. Moreover, it also has the second-highest beer tax in the union, at around $1.07 per gallon, after only Tennessee.

Tennessee

Before 2016, Tennessee taxed investment income, comprising most dividends and interest, but not income. Legislation approved in 2016 included a proposal to reduce taxes on unearned income by around 1% every year. This is until the tax was abolished at the beginning of 2021. To compensate for the gap, Tennessee imposes hefty sales taxes and the highest beer tax in the country, at around $1.29 per gallon.

Tennessee intends to entice retirees who rely primarily on investment income once the new legislation is fully implemented. The entire tax burden in the state is around 6.18 percent, which ranks third in the country.

Florida

This beautiful snowbird state has mild weather and a sizable elderly population. Florida's sales and property taxes are higher than the national average, yet the overall tax burden is only around 6.82 percent, ranking sixth in the country. Florida ranks around 35th in affordability, ten positions higher than Alaska, although it is still more expensive than other states, thanks to its higher living plus housing prices.

Texas

The Lone Star State abhors personal income taxes so much that it banned those in the state constitution. However, since services and infrastructure must be funded somehow, Texas relies on revenue from sales and excise taxes to cover the costs.

Sales tax may be as high as 8.25 percent in some areas. Its property taxes are considerably higher than in many other states, resulting in a total tax burden of around 8.20 percent of personal income. Nonetheless, Texans' overall tax burden remains among the lowest in the country, with the state placing 19th.

Wyoming

Wyoming is still the second least densely inhabited state, with an estimated six individuals per square mile, trailing behind only Alaska, which has around one person for every square mile.

Its citizens do not pay corporate or personal income tax, retirement income taxes and have minimal property and sales tax rates. The entire tax burden, which includes property, earning, sales, and excise taxes as a proportion of individual income, is around 6.47 percent, placing the state fourth lowest.

Washington

Washington has a population of young people, with just around 15.9% of its population being over 65. It has a significant number of employers, owing to the absence of a state-mandated corporation income tax. Residents do pay significant sales and excise taxes, and fuel in Washington is pricier than in many other states.

The state ranks 22nd out of 50, with a total tax burden of around 8.32%. Washingtonians are harmed by notably higher-than-average living and housing costs, which ranks the state 44th in affordability. For other inhabitants, this may not matter because their state was named the finest place to reside in by U.S. News as well as the World Report in 2019.

Nevada

Nevada is highly reliant on income generated by hefty sales taxes on everything, including groceries and clothing, as well as sin taxes on alcohol plus gambling and taxes on hotels and casinos. This leads to a total state-imposed tax burden of around 8.39 percent of its residents' income.

It has the greatest total tax burden among the states on this list, yet it still ranks 24th out of 50 when considered to all states. However, due to the high living standards and property prices, Nevada ranks at the bottom (42) in terms of affordability. The state is ranked around 37th on the "Best States to Live in" list by U.S. News and the World Report.

Income Tax in South Dakota

If you wish to escape income tax, you might consider moving to South Dakota, which has no income tax. This implies that your earnings from wages, capital gains, interests, or dividends are not subject to state taxation. Moreover, South Dakota taxpayers are not required to file a state tax return. Most of South Dakota's tax income is generated through general sales tax and specific sales tax.

Article XI of the state constitution grants the state the constitutional obligation to tax. Tax policies differ from one state to the next. States collect taxes to assist and support several state government functions. Tax receipts account for around 40% of overall state income. The remainder is derived from non-tax streams, including intergovernmental aid (for example, federal funding), lottery income, and fees.

Individual income tax, general sales tax, excise (or distinctive sales) taxes, and corporate income tax are the most common forms of taxes collected by state governments. New Census Bureau numbers back up South Dakota's image as a "low tax state," putting it around 50th nationwide in taxes received as a proportion of personal income.

This makes it the state with the lowest total tax burden.  However, many people have overlooked the reality that various taxpayers perceive South Dakota's tax system extremely differently since they are focused on the state's overall tax receipts. Around 20% of South Dakota's lowest-income citizens pay much more of their earnings (about 11.6%) to the state as well as local taxes than every group in the state.

South Dakota is very far from a low-tax state for low-income households. Only around eight states tax their lowest-income inhabitants more severely than South Dakota. There is no income tax; however, there are high sales as well as excise taxes. South Dakota's state and local tax receipts averaged around 7.9 percent of individual income in the financial year 2011.

This was significantly beneath the national average of approximately 10.6 percent, according to Census Bureau. South Dakota's low position is due, in part, to the fact that this is one of only nine states which do not charge a broad-based personal income tax. However, not levying an income tax has a cost. South Dakota's sales and excise taxes are around 17% more than the national mean used to fund local and state operations.

Per the Institute on Taxation and Economic Policy (ITEP), the lowest 20% of South Dakotan families pay 8.7% of their revenue in taxes, relative to 1% of revenue for the state's wealthiest citizens. Although South Dakota's statewide and county taxes average around 7.9 percent of income, various taxpayers have quite diverse experiences with the state's tax structure.

The Mount Rushmore State's choice not to collect a personal income tax was a huge advantage for the wealthiest 1% of South Dakota families (a subgroup with average earnings of more than around $1.1 million). This group pays only around 2.1 percent of its income in South Dakota taxes, which is the second lowest (or around 48th highest) state as well as local tax burden in the country.

Is it Better or Worse to Live in a State with No Income Tax?

There is no persuasive evidence that states lacking income tax surpass the ones with it, even if the levels are very high. Saving and improving state funding for education, universal healthcare, roadways, bridges, parks, as well as other infrastructure would do far more to increase equitable economic development and its inhabitants’ well-being than slashing income taxes.

The taxation argument is primarily ideological. Those with higher incomes may identify the disadvantages of taxing individual income. On the other hand, citizens who want their governments to assist in changing society and support such endeavors may choose an income tax. Nevertheless, before choosing a side, consider the following points:

● State governments use taxpayers' money to support road repair, police enforcement, and other public services. Property tax and sales tax, or income tax, are the most common sources of revenue for these services.

● States that do not have an individual income tax may require residents or tourists to pay a higher sales tax on food, clothing, and other commodities, like Nevada does. Alternatively, as in New Hampshire, homeowners wind up spending more on property taxes when compared to those in adjacent states.

● All those additional taxes add up to higher-than-average daily expenditures in several of those states. Per the statistics gathered by the Council for Community and Economic Research, Washington, Nevada, New Hampshire, Nevada, Florida, as well as South Dakota were among around 24 states with the highest cost of living back in 2018. Alaska is one of the costliest locations to live, although this is due in large part to its remoteness.

The Poor Benefit from Income Taxes

Income tax is a traditional means of wealth redistribution, and this can be done through the provision of student loans. It is often progressive, indicating that it taxes wealthier earnings at a rate higher than lesser earners. Some taxes, on the other hand, do not have this Robin Hood-like quality. Sales tax, for instance, is said to be regressive to mean that it is not affected by the buyer's income level. Everyone is treated the same way. Food, fuel, and other vital consumables all face charges.

Per the Institute on Taxation and Economic Policy (ITEP), such taxes impose an unjust weight on the poor. The basis for this is that a state's lowest earners spend the majority of their take-home pay on items susceptible to sales tax. The rich have a significantly lower percentage vulnerability to the sales tax since they may save a portion of income in 401(k) plans as well as other assets.

Eliminating income tax will increase take-home pay for everybody. It will make the state more appealing than its neighbors, attracting new firms, generating employment, and attracting employees. Is this, however, a true occurrence? Over the last several years, several economic policy bodies have fought back, raising doubts about if any of those statements are genuine.

When the leading nine states with the heaviest individual tax rates have been compared with the nine states which do not take a cut of its workers' income, statistics show that the group with no-tax had a significantly higher population development rate from around 2006 to around 2016 — around 11.9 percent verses about 5.6 percent, per the Institute on Taxation and Economic Policy.

Nevertheless, according to the ITEP, the more noteworthy result is that no-tax states have had difficulty adding employment at a rate adequate to keep up with their rising populations. Employment growth lagged population expansion in no-tax states by around 41%, relative to around 19% in states with high top tax levels.

Why is South Dakota Popular Among Billionaires?

South Dakota was the first state without the need for an income tax to enable trusts to operate indefinitely – this is a long time to avoid state-level income taxes. Several states have jumped on board, and some have established lengthy, yet fixed, deadlines for the creation of a trust. A trust in Nevada could last around 365 years, whereas one in Wyoming can survive for around 1,000 years.

Those periods are appealing to folks who desire to aid their family for future generations.  Even though there is no state income tax, South Dakota trusts must pay federal income taxes. According to Fidelity Investments, the maximum 37 percent tax rate on regular income now begins at around $13,051 for trusts. In addition, the highest 20% capital gains rate begins at a threshold of around $13,250. The highest rate arrives significantly faster for a trust than it does for individuals submitting their taxes.

However, to be taxed in the very first place, a trust must sell a capital asset or earn income. This can originate from items like bank account interest or stock dividends, the disposal of capital assets, or agricultural leasing income.

Taxation is Not Everything

To be sure, taxes comprise a significant portion of most people's finances. However, you may have additional reasons to relocate that are unrelated to your tax burden. For instance, you may require medical care in a higher-taxed location. You may also want to be near your children or grandkids. Or maybe you just appreciate the view from your rear window.

Some preferences are difficult to calculate using a spreadsheet. If you believe the administration should play an active role in improving society, you'll likely concur that state income tax is a great idea. Income tax enables the state to distribute income from the affluent to the poor, and officials may utilize state tax breaks to encourage people to donate to charity, purchase solar panels, or participate in other activities.

If you believe the government must keep out of the business, or if you make a higher salary, you could be content residing in one of America's nine no-income-tax states.

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