Selecting the Best State for Your Taxes: A Practical Guide for Individuals, Retirees, and Businesses
Choosing where to live, retire, or locate a business is increasingly influenced by tax considerations. Federal taxes form a baseline for everyone, but state and local taxes vary widely and can significantly change your after-tax income, cost of living, and long-term financial security. This guide breaks down how federal and state taxes interact, what to look for when comparing states, and practical steps for individuals, retirees, remote workers, and business owners who want to make smart decisions about tax residency and planning.
How Federal and State Taxes Fit Together
Federal taxes apply nationwide and fund programs such as Social Security, Medicare, national defense, and federal infrastructure. State taxes are set by each state and fund local services like education, roads, public safety, and health programs. The interplay between the two is a layered system: you pay federal taxes regardless of where you live, and state taxes on top of that depending on state rules.
Types of Taxes You’ll Encounter
When comparing states, consider the main categories of taxation:
Income Taxes
State income taxes may be progressive, flat, or non-existent. Progressive systems tax higher incomes at higher rates, while flat-tax states apply one rate to all taxable income. A handful of states levy no individual income tax at all, shifting the revenue burden onto sales, property, or corporate taxes.
Sales Taxes
Sales tax is levied on purchases and can be imposed at state, county, and local levels. Combined sales tax rates (state plus local) vary widely; some states have no statewide sales tax, while others have high rates and additional local levies. Sales taxes are regressive in nature because lower-income households spend a larger share of their income on taxable goods.
Property Taxes
Property taxes are charged by local governments and are often a primary funding source for public schools. Effective property tax burdens depend on millage rates and property value assessments. States may have high property taxes but low income taxes, or vice versa.
Payroll Taxes
Payroll taxes include federal Social Security and Medicare taxes (FICA), federal unemployment tax (FUTA), and state unemployment taxes (SUTA). Employers and employees split some payroll taxes; unemployment taxes are primarily employer responsibilities but can indirectly affect wages and hiring. Some states also have additional payroll-based taxes or disability insurance contributions.
Corporate, Franchise, and Business Taxes
Businesses face corporate income taxes, franchise taxes, gross receipts taxes, and minimum taxes in some states. These can influence location decisions for businesses and entrepreneurs. Even businesses that do not show taxable profit may owe minimum business taxes or gross receipts taxes in specific jurisdictions.
Federal Tax Fundamentals to Keep in Mind
Before zeroing in on state differences, understand the federal baseline: the U.S. uses progressive federal income tax brackets, exemptions, deductions, and credits. Federal tax credits—like the Child Tax Credit or education credits—directly reduce tax liability, while deductions reduce taxable income. Payroll taxes are mostly flat percentages applied to wages up to a cap for Social Security; Medicare has no cap and includes surtaxes for high earners. Capital gains, dividends, and retirement distributions have distinct federal treatments that interact with state rules.
Federal Tax Brackets Explained
Federal tax brackets determine marginal tax rates—how much tax you pay on the next dollar of income. Knowing your marginal rate helps with retirement withdrawal strategies, timing capital gains, and charitable giving. Remember that state taxes may affect effective marginal tax rate, particularly in states with high top state brackets.
Federal Credits vs Deductions
Credits provide dollar-for-dollar reductions in federal tax owed, while deductions reduce taxable income. Many states conform to federal definitions for deductions and credits, but some decouple entirely or partially, creating differences between federal and state taxable income.
How States Structure Their Taxes: Models and Trade-Offs
States choose different tax mixes to raise revenue. Understanding the trade-offs helps you weigh higher income taxes against lower sales taxes or property taxes.
States with No Income Tax
Several states—like Florida, Texas, and Washington—do not impose a state individual income tax. These states generally rely more on sales, property, and business taxes. For retirees or high earners, the lack of state income tax can be a big draw, but higher property values and sales taxes can offset some of the advantage.
Flat Income Tax States
Some states levy one flat rate for all taxpayers. Flat taxes offer predictability and simplicity, but they are often less progressive than graduated rate structures. Whether a flat tax is beneficial depends on your income level relative to the flat rate and the state’s alternative revenue sources.
Progressive Income Tax States
Progressive states tax higher incomes at higher rates and may provide more generous services or broader social programs. High top marginal rates primarily impact higher earners, business owners, and investment income—but state-level deductions and credits can reduce effective rates for many taxpayers.
Sales Tax Heavy vs Property Tax Heavy States
Some states compensate for low income taxes with high sales taxes and significant local add-ons, which can increase the cost of consumption. Others rely heavily on property taxes, which affects homeowners more than renters. For owners of high-value property, states with high property taxes can be costly over time.
Retirement and Taxation: What Retirees Should Watch
Taxes can significantly affect retirement income streams. The same dollar of Social Security benefits, pension distributions, or IRA withdrawals can have different tax results depending on state rules.
Federal Taxation of Retirement Income
Social Security benefits can be partially taxable at the federal level, depending on combined income. Traditional IRA and 401(k) withdrawals are federally taxable as ordinary income when distributed, while Roth IRA distributions are generally tax-free if conditions are met. Capital gains and dividends, which retirees might rely on, have favorable federal rates in many situations.
State Taxation of Retirement Income
States vary widely: some fully tax retirement income, some tax partially, and several do not tax Social Security at all. A few states exclude all or part of pension or retirement account withdrawals. When choosing a retirement destination, check how Social Security, pensions, IRAs, 401(k)s, and other retirement income are treated.
Which States Are Tax-Friendly for Retirees?
Tax-friendly states for retirees often have no income tax or provide generous exclusions for retirement income, low property taxes, and modest sales taxes. However, the most tax-friendly state for one retiree may be poor for another—healthcare costs, housing, property taxes, and estate considerations all matter.
Working Remotely, Multi-State Income, and Residency Rules
The rise of remote work has added complexity to state tax planning. When you live in one state and work for an employer in another—or perform work while traveling—multi-state rules and withholding can become confusing.
Tax Residency vs Domicile
States use rules like residency, domicile, and statutory presence to determine taxing rights. Domicile is your permanent home; residency often depends on the number of days spent in a state. Part-year residents have to allocate income, and nonresidents may owe tax on income earned within a state.
Working Remotely: Who Gets to Tax Your Income?
Generally, states tax income sourced to work performed within their borders. If you live in State A and perform work there for an employer located in State B, State A typically has the primary claim. But exceptions, reciprocal agreements, and employer withholding practices can complicate matters. The Wayfair decision and economic nexus rules also affect businesses that sell across state lines.
How to File When You Have Multi-State Income
You may need to file a resident return in your home state and nonresident returns in states where you earned income. Many states offer credits for taxes paid to other states to mitigate double taxation on the same income. Proper allocation and sourcing of income are crucial to avoid overpaying.
Tax Credits, Deductions, and State Conformity
State tax systems often start by mirroring federal definitions and then conforming (or decoupling) from federal law changes. Understanding whether a state conforms to federal tax law helps anticipate differences in your state tax bill after federal reforms.
SALT Deduction and Its Limits
The federal SALT deduction cap limits the state and local taxes you can deduct on your federal return. High-tax states often lament this cap because it effectively increases the federal tax burden on their residents. Some states have responded with workarounds—like state credits tied to pass-through entities—so be aware of state-specific fixes and their potential effects.
Common State Tax Credits
States may offer their own versions of earned income tax credits (EITC), child tax credits, education credits, energy credits, and property tax relief. These credits can significantly affect the net state tax you owe and are an important part of evaluating a state’s tax friendliness.
Business Considerations: Where to Locate or Incorporate
Business taxes matter for entrepreneurs and corporations. State corporate income taxes, apportionment rules, franchise taxes, and gross receipts taxes can change where it’s most economical to operate or incorporate.
Apportionment and Nexus
States use apportionment formulas—often combining sales, payroll, and property factors—to allocate business income among states. Nexus rules determine whether a state can tax an out-of-state business. Wayfair clarified that economic nexus based on sales thresholds can create tax obligations for remote sellers, increasing the importance of understanding sales tax nexus rules.
Which States Are Business-Friendly?
States promote competitiveness through low corporate rates, favorable apportionment formulas, tax incentives, and grants. However, incentives often come with strings attached, and states may recapture credits if job or investment targets aren’t met. Business owners should evaluate overall operating costs—including labor, utilities, regulatory environment, and local taxes—rather than focusing solely on headline tax rates.
Choosing a State: A Practical Checklist
When comparing states for residency, retirement, or incorporation, use a checklist to weigh the trade-offs. No single factor should dominate; combine tax considerations with lifestyle, healthcare, housing, and family needs.
Income Tax and Marginal Rates
Check whether a state has no income tax, a flat tax, or a progressive schedule. Consider how state deductions, exemptions, and credits change effective rates, and whether state tax brackets will push you into higher tax bands.
Sales Tax and Spending Patterns
Compare statewide sales tax rates and typical local add-ons. If you spend heavily on taxable goods—vehicles, dining out, or services that are taxed in a state—you’ll feel sales taxes more than income taxes.
Property Taxes and Homeownership Plans
Assess property tax rates and the frequency and method of property reassessments. If you plan to buy a home or hold high-value property, property taxes can outweigh income tax savings over time.
Retirement Stacks: How Retirement Income Is Treated
Evaluate state taxation of Social Security, pensions, IRAs, 401(k)s, and retirement account rollovers. States with broad exclusions can be especially attractive to retirees with large tax-deferred balances.
Sales and Use Taxes on Online Purchases
Find out whether a state applies use tax to online purchases and if marketplace facilitator rules mean the marketplace collects sales tax automatically. These rules affect the true cost of living and e-commerce habits.
Estate and Inheritance Taxes
Estate taxes and inheritance taxes still exist in several states. If you expect to pass significant wealth to heirs, state-level estate or inheritance taxes can be a decisive factor.
Healthcare, Cost of Living, and Public Services
Taxes fund public services and infrastructure. A low-tax state might have fewer public services or higher out-of-pocket costs for education and healthcare. Balance tax savings against the value of services you expect to use.
Special Tax Incentives
Investigate state and local incentives for retirees, small businesses, startups, and green energy investments. Incentives can reduce upfront costs but review eligibility, clawback provisions, and long-term implications.
Case Studies: Real-World Examples
Here are three simplified scenarios that illustrate trade-offs when selecting a state for tax purposes.
High Earner Weighing Income vs Property Taxes
A high-income professional considering a move from a high-income-tax state to a no-income-tax state must examine not just top marginal rates but the other costs: higher property taxes, local sales taxes, and potentially higher housing prices. Sometimes the net benefit is clear, but in high-cost housing markets, tax savings can be eroded by increased home prices or local levies.
Retiree Choosing by Retirement Income Treatment
A retiree with substantial pension and IRA balances might save thousands annually by living in a state that exempts pension income and Social Security, compared with a state that fully taxes retirement income. But factoring in healthcare access, property taxes, and family proximity is critical before choosing solely based on tax treatment.
Small Business Deciding Where to Incorporate and Operate
A small business owner should compare state corporate tax rates, franchise and minimum taxes, and the apportionment formula. A low corporate rate is attractive, but if the state taxes based on gross receipts or has high filing fees and compliance costs, the overall burden could be heavier than a state with a modest rate and simpler rules.
Navigating the Move: Residency, Withholding, and Filings
If you decide to change states, follow steps to establish residency and manage tax responsibilities to avoid surprises.
Establishing Domicile
Take clear actions to establish your new domicile: change your driver’s license, register to vote, transfer vehicle registrations, update your address on tax forms, sign a lease or purchase a home, and spend time in the new state. Keep documentation to support your claim if the previous state questions your move.
Managing Withholding and Estimated Taxes
Inform your employer of your new state so state tax withholding aligns with residency. If you are self-employed or have significant investment income, set up state estimated tax payments to avoid underpayment penalties.
Filing Final Returns and Credits for Taxes Paid to Other States
File a part-year or final resident return in your old state and a part-year resident return in your new state. Keep careful records of income sourced to each state. If you paid taxes to a state where you don’t reside, check whether your home state offers a credit for taxes paid to another state to prevent double taxation.
Practical Tools and Resources
Use state department of revenue websites for up-to-date tax tables, credits, and filing forms. Tax calculators and cost-of-living comparisons can help quantify trade-offs. When complexities arise—such as significant business interests, inter-state trusts, or large estates—engage a CPA or tax attorney experienced in multi-state taxation.
When to Get Professional Help
Consult a professional if you:
– Have income in multiple states or significant investment and rental income.
– Run a business with operations in several jurisdictions or complex apportionment needs.
– Are a high-net-worth individual concerned about estate, gift, or inheritance taxes.
– Face an audit or notice from a state tax authority about residency or sourcing disputes.
Common Pitfalls and How to Avoid Them
Several common mistakes can turn a carefully planned move into a tax headache.
Assuming No Income Tax Means Low Overall Taxes
States without income taxes often make up revenue through higher sales taxes, property taxes, or business levies. Run a total-tax comparison that includes likely spending and homeownership scenarios to get a realistic picture.
Ignoring Local Taxes and Fees
Local jurisdictions add sales, property, and special district taxes. In some metro areas, combined sales tax rates can be among the highest in the nation, negating income tax advantages.
Failing to Update Withholding and Records
If you move mid-year and don’t change your withholding or estimated payments, you can end up with penalties or large balances due at filing. Update your employer and track days spent in each state to support your filings.
Emerging Trends and the Future of State Tax Competition
State tax competition continues to evolve. Remote work has increased scrutiny on sourcing rules and nexus for businesses. Some states are experimenting with tax incentives to attract remote workers and retirees. On the federal side, potential reforms could alter deductions, credits, or SALT treatment, which would ripple through state systems depending on whether states conform to federal changes.
Policy Considerations
Policymakers balance competitiveness with revenue needs. States that cut taxes without addressing structural deficits may face service cuts or property tax hikes. Conversely, states raising taxes may fund improved infrastructure, attracting businesses that value public goods.
Choosing the best state for your taxes is a multidimensional decision—one that blends numbers with lifestyle and long-term goals. By understanding how federal and state taxes interact, evaluating the full burden of taxes (income, sales, property, payroll, and business taxes), and following a careful checklist when relocating or starting a business, you can make choices that support financial health and quality of life. Thoughtful planning, combined with professional advice when needed, helps ensure your state choice serves your priorities for years to come.