January 8, 2020 Accounting & Taxes en_US There are only seven states with no income tax. Find out what they are and how state income tax impacts you as a small business owner. https://quickbooks.intuit.com/cas/dam/IMAGE/A5UETbNWP/thumbnail_states-with-no-income-tax_featured.jpg https://quickbooks.intuit.com/r/accounting-taxes/states-with-no-income-tax-a-complete-guide-to-income-tax-rates/ States with no income tax: A complete guide to income tax rates
Accounting & Taxes

States with no income tax: A complete guide to income tax rates

By Chris Scott January 8, 2020

According to the IRS, in 2016 — the most recent data provided by the organization — Americans filed more than 150 million individual income tax returns, reporting nearly $10.5 trillion in income. Many of these 150 million Americans had to file returns at the state level as well.

However, not all of them had to do so. Why? Because there are several states with no income tax. Today, we’ll give you a guide to the states with no income tax. Not only will we outline the income tax rates in different states, but we’ll also cover how living or working in no-tax states can impact your small business.

What is income tax?

An income tax is any tax that the government levies directly on income. The most common form of income tax is the annual tax that occurs on personal income, which you file your tax return for every April 15.

In the United States, Americans are subject to federal income taxes. The IRS determines whether you have to pay income taxes and how much you owe based on your gross income, your age and your marital status. Your gross income is a pre-tax tally of all of the money that you earned throughout the year. Generally, the thresholds are as follows:

Filing status: single

  • 65 or older, gross income threshold = $13,600
  • Under 65, gross income threshold = $12,000

Filing status: head of household

  • 65 or older, gross income threshold = $19,600
  • Under 65, gross income threshold = $18,000

Filing status: married, filing jointly

  • Both spouses 65 or older, gross income threshold = $26,600
  • One spouse 65 or older, gross income threshold = $25,300
  • Both spouses under 65, gross income threshold = $24,000

Filing status: married, filing separately

  • Any age, gross income threshold = $5

Filing status: qualifying widow with dependent child

  • 65 or older, gross income threshold = $25,300
  • Under 65, gross income threshold = $24,000

The United States uses a progressive tax structure when collecting income tax. A progressive tax structure means that the tax burden increases as you make more money. The Tax Foundation provides a breakdown of the federal income tax brackets. The federal personal income tax rates fall into seven brackets ranging from 10%-37%.

The federal income tax rates are different from state income tax rates. States have their own rates that are dependent on where you live and earn your income. If you make enough income to file a federal income tax return, there’s a strong chance that you owe state tax as well.

State income tax rates

When it comes to determining state taxes, you’ll find that there are generally three broad categories:

  1. States with no income tax
  2. States with a flat tax
  3. States with a progressive tax

Every one of the states in the US falls into one of these three categories. Generally, you’ll find that federal income tax rates are higher than state tax rates. Let’s take a look at the different state tax structures.

States with no income tax

The following states do not charge income taxes on personal income earned, meaning the state tax rate on income is 0.0%:

  • Alaska
  • Florida
  • Nevada
  • South Dakota
  • Texas
  • Washington
  • Wyoming

States with flat income taxes

These states charge a flat rate on income earned. This means that everyone filing a return pays the same tax rate. These states have different definitions as to what constitutes income. For instance, Tennessee and New Hampshire only charge taxes on interest, dividends and investment income. Others rely on adjusted gross income, including what you earn at your job. The tax rates are as follows:

  • Colorado: 4.63% for those who have to file a federal return
  • Illinois: 4.95% if the total earned exceeds the $2,225 exemption
  • Indiana: 3.23% for those earning at least $1,000 in income
  • Kentucky: 5.00% if the modified gross income is at least $12,140
  • Massachusetts: 5.05% for those making at least $8,000
  • Michigan: 4.25% for those whose adjusted federal gross income exceeds the $4,050 Michigan state exemption
  • New Hampshire: 5.00% on interest and dividends
  • North Carolina: 5.25% for those with federal gross income of at least $8,750
  • Pennsylvania: 3.07% for those who earn at least $5
  • Tennessee: 2% on interest and dividends
  • Utah: 4.95% regardless of income earned

States with progressive income taxes

Every other state in the United States, including Washington, D.C., has a progressive tax structure for income taxes. The rate that you’re subject to depends on the gross income that you report. We’ve provided a brief breakdown of the tax rates for each of these state below:

  • Alabama: Three brackets ranging from 2%-5%
  • Arizona: Five brackets ranging from 2.59%-4.54%
  • Arkansas: Six brackets ranging from 0.9%-6.9%
  • California: Nine brackets ranging from 1%-12.3%
  • Connecticut: Seven brackets ranging from 3%-6.99%
  • Delaware: Seven brackets ranging from 0%-6.6%
  • District of Columbia: Five brackets ranging from 4%-8.95%
  • Georgia: Six brackets ranging from 1%-5.75%
  • Hawaii: 12 brackets ranging from 1.4%-11%
  • Idaho: Seven brackets ranging from 1.125%-6.925%
  • Iowa: Nine brackets ranging from 0.33%-8.53%
  • Kansas: Three brackets ranging from 3.1%-5.7%
  • Louisiana: Three brackets ranging from 2%-6%
  • Maine: Three brackets ranging from 5.8%-7.15%
  • Maryland: Eight brackets ranging from 2%-5.75%
  • Minnesota: Four brackets ranging from 5.35%-9.85%
  • Mississippi: Three brackets ranging from 3%-5%
  • Missouri: Nine brackets ranging from 1.5%-5.4%
  • Montana: Seven brackets ranging from 1%-6.9%
  • Nebraska: Four brackets ranging from 2.46%-6.84%
  • New Jersey: Six brackets ranging from 1.4%-10.75%
  • New Mexico: Four brackets ranging from 1.7%-4.9%
  • New York: Eight brackets ranging from 4%-8.82%
  • North Dakota: Five brackets ranging from 1.1%-2.9%
  • Ohio: Eight brackets ranging from 0%-4.997%
  • Oklahoma: Six brackets ranging from 0.5%-5%
  • Oregon: Four brackets ranging from 5%-9.9%
  • Rhode Island: Three brackets ranging from 3.75%-5.99%
  • South Carolina: Six brackets ranging from 0%-7%
  • Vermont: Five brackets ranging from 3.35%-8.75%
  • Virginia: Four brackets ranging from 2%-5.75%
  • West Virginia: Five brackets ranging from 3%-6.5%
  • Wisconsin: Four brackets ranging from 4%-7.65%

How do these rates impact small business owners?

These rates can impact small business owners in a few different ways. Much of it has to do with how you choose to structure your company and whether you’ve hired employees.

If you’ve structured your company as a pass-through business, then you won’t need to pay corporate income taxes. Corporate income taxes are a bit different from the personal income taxes that we’ve just discussed above — we’ll touch more on corporate income below.

With a pass-through business structure, you “pass” your business income through to your personal tax return. There, it’s subject to the state government tax rates. Pass-through entities include:

  • Sole proprietorships
  • Partnerships
  • Limited liability companies
  • S-corporations

If you don’t have a pass-through entity, then your business is subject to corporate tax rates. The federal corporate tax rate is 21%. Unlike the personal income tax rate, which is progressive, the corporate federal tax rate is flat.

Tax law dictates that you must pay corporate tax at the state level as well. Wyoming and South Dakota are the only states without a corporate income tax. The Tax Foundation also provides a breakdown of state corporate income tax rates.

How do you know if you owe income tax?

If you’re a new business owner, you want to make sure that you’re filing your taxes correctly. Otherwise, you could be subject to back taxes and other penalties. It’s in your best interest to double-check all your relevant tax laws.

The first thing you can do is contact your state’s financial or accounting department. Each state has a department that handles taxes. There, you can learn more about whether you owe income tax and, if so, how much.

Remember that you may need to file taxes in every state in which you operate, conduct business, own property, or make sales. Be sure to learn more about the states in which you operate to ensure you’re settling your tax burden.

You can also contact a trusted accounting professional or lawyer. These individuals can sort through your business files to determine which states you owe taxes in for a given tax year. They can also provide you with tips on how to secure a low tax rate moving forward. These individuals are professionals and know more about tax income than you do, so they are your best resource.

Lastly, make sure you’re using reliable accounting software for your business. The best accounting software makes things easy for filers. The software can keep track of business transactions throughout the year and let you know the total tax that you’ll owe come filing time.

Are income taxes the same as property taxes?

Income taxes are not the same as property taxes. For one, the United States federal government is tax-free when it comes to property taxes. The only property taxes levied come from state governments, and property tax rates vary from state to state.

A property tax charges you for owning land and buildings. Only property owners have to pay these taxes. So if you rent your office building, you’re not required to pay property taxes, although you still may need to pay income tax. Conversely, if you own your office building, you are going to need to pay property taxes in addition to income taxes.

Are income taxes the same as sales taxes?

Income taxes and sales taxes are also quite different. State sales taxes are those that occur on retail sales. Your transaction may also be subject to local sales taxes depending on where you live. There is currently no federal sales tax rate.

45 state governments collect state sales tax. Additionally, local governments in 38 states collect some form of local sales tax. Retailers are responsible for collecting all sales taxes when conducting a sale. The retailer must then pass the collected taxes on to the respective government entity.

Unless you’re buying a good, sales tax doesn’t cost you anything as a business owner. All you need to do is collect the applicable tax on each transaction. For instance, imagine you complete a $100 sale in a state with a 5% sales tax rate. You should charge the customer $105 and pay $5 to the state. You are acting as a middleman.

But, imagine the corporate income tax rate is also 5%. You would owe the government 5% based on year-end revenue. So, essentially, you receive $95 of the $100 sale, the consumer pays $5 in sales tax, and the government gets $10.

Do your due diligence when it comes to taxes

Taxes can be confusing, especially for new small business owners. Not only do you have to pay federal taxes, but state and local taxes as well. These rates all vary depending on where you conduct business.

Take the time to ensure you’re filing taxes correctly. Not only will this save you money by reducing your chances of being penalized, but it will also save you from having to correct headaches down the road.

To make tax time easier, consider using software designed to help the self-employed organize their expenses and maximize deductions.

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Chris Scott is a finance expert, consultant, and writer. He graduated from the University of Maryland with a degree in Finance and currently resides in Boston, MA. Read more