High Earners Face State Tax Hikes

By Kimberly Palmer

This guide to the highest-tax states can help top-earners lower their tax burden

If you're a millionaire living in California or New Jersey, you might want to consider moving. That's because high earners in those states charge taxpayers some of the highest rates in the country, while others, such as Alaska, charge no income tax at all. When you're bringing home a lot of dough, those differences add up.

"If you live in a state like New York or New Jersey, or any of the East Coast states, it will really impact your bottom line," says Kathleen Thies, state tax analyst for the tax firm CCH. She says budgetary pressure in many states has led lawmakers to implement bigger tax hikes among high earners. California, for example, added 0.25 percent to each tax bracket for 2009 and 2010, which brings the top marginal tax rate in that state to 10.55 percent. "Politically, it's never a great move to increase taxes, but states have been in trouble, and that's why they're taking these steps," says Thies.

It's not just income taxes, either. Mark Robyn, staff economist for the Tax Foundation, a Washington, D.C.-based research group, says when you consider the entire tax burden states impose, including sales and local taxes, as a percentage of state income, the tax burden in New Jersey is 12.2 percent, about double that of Alaska.

The most expensive states for high earners tend to be on the East and West Coasts, says Thies, but generalizations are difficult to make, especially because tax laws change quickly. In New Jersey, for example, the so-called "millionaire's tax" expired last year, when the highest rate, which applies to those earning over $500,000, fell from 10.75 percent to 8.97 percent. That new rate, says Thies, "is still very high as far as state tax rates go."

Other states still impose "millionaire's taxes," which refer to higher tax rates for people earning high salaries, often $250,000 or $500,000 and up. "It's a bit of a misnomer because it doesn't just apply to millionaires," says Robyn. "[Millionaire's taxes] don't reflect the pattern of lower tax rates where it increases every $10,000. Once you hit a certain income level, you get hit with all these extra taxes," he adds. Even Connecticut, which charges a relatively modest 6.5 percent top tax rate on income over $500,000, is considered to impose a millionaire's tax since the next rate starts at $10,000. In other words, big earners feel singled out.

Hawaii is also expensive with a top income tax rate of 11 percent. The District of Columbia charges a top rate of 8.5 percent, but also froze personal exemptions and deductions through 2013, which means many taxpayers will owe more. Oregonians earning over $125,000 face a new tax bracket of 10.8 percent, and those earning over $250,000 will now pay 11 percent through 2011. New Yorkers earning upwards of $500,000 pay 8.97 percent, while individual filers earning over $200,000 also pay the relatively steep rate of 7.85 percent.

Thies says states that have top marginal tax rates over 6 percent are relatively pricey; lower-rate states such as Arizona, New Mexico, and Mississippi charge top rates around 5 percent or below. Alaska, Florida, Nevada, New Hampshire, South Dakota, Texas, Washington, and Wyoming do not charge general income taxes. Of course, residents still fund state activities in other ways, including through property taxes and sales taxes, but the overall tax burden on residents in these spots tends to be lower.

So do high earners "vote with their feet," as economists like to say, and move to cheaper states? Sometimes, says Robyn. "Economists generally agree that taxes affect people's behavior," he says. When people can easily choose between two nearby states, such as Maryland and Virginia, they likely take taxes into account, especially if they are high earners with a hefty tax burden and the means to move.

That's one reason New Jersey got rid of its millionaire's tax, says Thies. "It wasn't very palatable. It puts a freeze on people wanting to live in New Jersey when they have a lot of money, and [lawmakers] don't want to drive people out of the state," she adds.

Retirees, in particular, often consider moving, and warm weather isn't the only reason Florida is a popular choice. In addition to its lack of state income tax, the state does not tax Social Security income or pension income, either. According to Thies, retirees are paying special attention to how tax rates differ by state now, in the wake of the recession, when so many people's savings have been battered. Where they choose to live in retirement, she says, plays a major role in the lifestyle they can afford, partly because of how much tax rates differ.

According to Thies's analysis, Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming are the seven states that do not impose state income taxes on retirement income in addition to not charging state income tax. New Hampshire and Tennessee, meanwhile, charge income taxes only on dividends and interest (5 percent and 6 percent, respectively.) Maine, on the other hand, charges a relatively steep rate of 8.5 percent on income over $19,950 ($39,900 for joint filers). Federal law gives states wide latitude in how they decide to tax Social Security and pension income, which is why rates vary so widely.

The good news for big earners is that many of the recent tax hikes apply for a limited time only. In Oregon, for example, the recent hikes will be reversed in 2012, and Thies says she expects other states to reverse their tax rate increases as well, especially as the economy, and state budgets, slowly improve.

But when many states are raising their rates at the same time, as they're doing now, it can be harder to dodge the tax man. Unless, of course, you're considering a move to Alaska.

Kimberly Palmer is the author of the new book Generation Earn: The Young Professional's Guide to Spending, Investing, and Giving Back .

Personal Finance - High Earners Face State Tax Hikes