Pros & Cons of State Income Tax

For millions of taxpayers, federal income tax returns are the only major requirement during tax season each spring. However, for the residents of 41 states, state income tax is an additional burden. State governments use income tax to supplement the money they raise through sales tax, excise tax and property tax to fund local services.

Function

State income tax works much like federal income tax. Citizens must report all income, including wages from a job, interest from investments and capital gains from property and stock sales. State income tax allows for deductions, just like federal income tax. Taxpayers may usually choose between filing a paper tax return or filing online and paying tax (or receiving a refund) electronically.

Differences

States charge income tax at a significantly lower rate than federal income taxes. Each state has its own system for determining tax brackets based on income and filing status. State tax codes also differ, which means that something that qualifies as a deduction for federal income taxes, may not qualify as a deduction for the state. The different tax codes also mean that different types of income, including earned income and investment income, carry a different tax liability in each state.

Benefits

The key benefit of state income tax is that it gives more money to the state government to put toward public programs and funds for the government's basic functions. States use income tax money to do everything from building and repairing roads to investing in infrastructure, education and job creation. States that levy personal income tax can raise funds to balance the budget by increasing tax rates. When states spend the revenue from income taxes wisely, all residents stand to benefit.

Drawbacks

State income tax is an additional responsibility for taxpayers, on top of federal income tax. This means that taxpayers must file two separate returns and pay tax to each government. A second paperwork process means more room for error, and more time needed for completion. Because state income taxes are so different from one state to another, residents may choose to relocate based on tax rates, which can lead to a population decline in states that raise income taxes.

Considerations

It's important to remember that state income tax generally costs less than federal income tax. States without personal income tax may have higher sales tax rates to make up for the revenue they might otherwise gain by taxing income. You need to incorporate all of this information when you compare taxes in two locations for a fair, useful result.

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