Following on from last week’s post, I’ve continued calculating the income tax that an early retiree (what I like to call “Jailbroken”, in a financial sense) who brings in $37,000 in investment income (interest, dividends, capital gains) would expect to pay to the various U.S. states. As a reminder, the specific assumptions about income that I made are:

• Ordinary dividends: $20,000, of which 80% ($16,000) are qualified dividends
• Taxable interest: $3,500
• Tax-exempt interest: $1,500
• Capital gains on sale of stock: $12,000

For the most part (but not always), states don’t care where the money came from (it’s all just income), so the total income here is $37,000. This should give a $50,000 lifestyle if the capital gains come from sale of stock whose value has roughly doubled since purchase.

As far as details go, I used the married-filing-jointly status, with one child, because that’s me. I didn’t account for any situation-specific tax credits in any state, because I don’t qualify for any and that would just muddle the comparison. Your mileage may vary.

The new additions to the table below complete all states along the Eastern seaboard and the Gulf coast. The results already included all of the Mountain west. What remains to be done is mostly the midwest, which will come next.

The Results

No state has yet tied California’s exemplary performance (of zero tax liability); in fact, the lowest-tax addition to the table is in fourth place (Connecticut). Step across the border to Massachusetts, though, and you enter the highest-tax state that I’ve yet encountered. Step across the border again to Rhode Island, and you fall back into the sixth-lowest tax liability in the table.

This border-stepping difference is a common theme, actually. Living in North Carolina would cost about $1,000 in taxes; hop over to South Carolina and owe only $400.

The wealth of states doesn’t help much in explaining the differences. Arizona and Alabama, for example, rank 44th and 45th in terms of GDP per capita; but their tax liabilities are different by $1,000, enough to put them at opposite ends of the cost spectrum. Similar politics doesn’t necessarily mean similar tax structures; California and Massachusetts would seem to be equally blue states, to recite a stereotype. They are at the top and the bottom of the table.

I’ll save any further commentary for the next installment, when I’ve finished calculating the taxes in the rest of the country. I’ll just repeat here what I said before: state taxes are one small component of the cost of living in any given state, with other significant components being property and sales taxes, general costs of necessities like groceries and fuel, differing necessities like heating oil in the northeast vs air conditioning in the southwest…so it would be unwise to base any decisions about where to relocate based only on the income tax numbers.

Also, to repeat: I’m no accountant, I’m just decent at following instructions. And the results below are provided only for entertainment value (oh, so entertaining!).

Notes

• If interest income is from U.S. federal obligations (Treasuries) it is not taxable as income by the states. In the above, I did not take that into account. But say, for example, that the $3,500 of interest income above is from a total-bond-market fund, such as the popular Barclay’s Aggregate…in that case, something like 30%–40% of the interest is from Treasuries and the taxable income in each state would be lower by about $1,000. This would have an almost unnoticeable effect in the high-tax states but would make a very measurable difference in the low-tax states.
• New Jersey is easily the most infuriating state yet, if only because even getting the tax forms from the official source requires installing Adobe Acrobat. Since I refused to do that, I got it from a third-party source. Although I don’t guarantee any of the numbers here, I really don’t guarantee New Jersey’s. On a practical note, New Jersey allows the deduction of property tax, or if a renter, 18% of rent. For someone renting a place at about $1,000/month, that will reduce the taxes by about $50. This isn’t included in the table, though, because the actual amount will be very situation-specific.
• Maryland collects local tax as well as statewide tax through its state tax forms. I used the lowest local rate in calculating the number in the table. Using the highest local rate, the tax could be as great as $1,809.

I’m a detail-oriented person—too detail-oriented, sometimes, for my own good. While I’m perfectly capable of thinking big-picture, I sometimes just enjoy figuring things out, even if those things aren’t particularly important in the grand scheme of things. There are many such examples in the realm of personal finance, and one of those is state income taxes. For the most part, we (like most other people) will choose where we want to live when we’re Jailbroken partly by considering costs, but mostly by considering where we want to live and what we want to do. So cost of living is an important but secondary factor, and state income taxes are a secondary factor when determining cost of living. In engineering we often just ignore such second-order effects—but, of course, we have to know that they’re second-order before we ignore them.

There was a discussion recently over at Our Next Life (here) about whether California was a good place for an early retiree to live, given its reputation as a high-tax state. The prevailing answer to that question was based on, first: do they want to live in California? Yes. Then: can they afford the taxes? Yes. But it was an open question about what it meant to afford the taxes.

So my curiosity led me to wonder how the states stack up in terms of taxes on what we might expect an early-retiree budget to look like, rather than based on the metric of highest marginal rates, which is how states are usually ranked. Online tax estimators aren’t really much help in this, because the best of them seem to ignore things like deductions and credits, which can vary wildly between states, and they generally assume your income is earned income, which can be treated very differently than investment income. So, wanting to know what we’re dealing with, I decided to fill out some tax forms and see.

Estimating State Taxes

Filling out state tax forms can be easier than the federal forms, often because the numbers are based on the federal numbers, which you’ve presumably already calculated; but they can also be more difficult, because if the rules are arcane they can be hard to apply properly. I give kudos in particular to West Virginia, which has a form that fills itself out once you’ve given it your numbers: why don’t all states do that? At any rate, the process is actually pretty repetitive and I quickly got the hang of how the states deal with income. So except for the outliers that have strange rules, it didn’t take much time.

As of right now, I’ve calculated the taxes for 17 states (plus 7 that have no income tax) that represent places that are attractive to me for one reason or another. I’ll add to the list as time goes on, which will be permanently hosted at http://plottingforjailbreak.com/state-taxes/. The goal is to have all 50 states represented. The data table for what I have now is reproduced below.

For income, I assumed the following:

• Ordinary dividends: $20,000, of which 80% ($16,000) are qualified dividends
• Taxable interest: $3,500
• Tax-exempt interest: $1,500
• Capital gains on sale of stock: $12,000

For the most part (but not always), states don’t care where the money came from (it’s all just income), so the total income here is $37,000. This should give a $50,000 lifestyle if the capital gains come from sale of stock whose value has roughly doubled since purchase.

As far as details go, I used the married-filing-jointly status, with one child, because that’s me. I didn’t account for any situation-specific tax credits in any state, because I don’t qualify for any and that would just muddle the comparison. Your mileage may vary.

A couple surprises that have shown up already:

• California, despite being considered a high-tax state, would tax this income profile at $0. The state’s tax structure is highly progressive and taxes don’t even kick in until an income level a bit higher than what is assumed here.
• New Hampshire, often considered a no-tax state, has one of the highest taxes in the ranking. That’s because, while they don’t tax earned income, they do tax investment income, without deduction or exemption. All else being equal, one would save almost $1,000 per year by just hopping the border and settling in Vermont or Maine instead.

All else is not always equal, though, and state income taxes are only one part of the total financial picture for someone in Jailbreak. Property taxes, healthcare costs, and overall cost of living can swamp the effect of state taxes. But like anything else, you never know until you sit down and figure it out.

A note about the rankings: the table is sorted in order from lowest tax liability to highest. This ranking would probably be preserved fairly well if the income in question varied plus or minus around $10,000; but much more variation upward would start to shift things significantly as states with progressive tax systems begin to overtake those with flat taxes. For a similar ranking of states, but for roughly double the income, see State of Confusion: Does Location Matter for Retirement Taxes? (Beware the limitations of the tax estimator used for those estimates, though: the “New Hampshire effect” is clearly absent there, for example.)

The Rankings

Note: there is an updated table with 13 additional states in a more recent post.

Obligatory note: I’m not an accountant, and this list is for educational purposes only. I am very good at following instructions, though, which is almost all of the battle when filling out tax forms.

Notes

• If interest income is from U.S. federal obligations (Treasuries) it is not taxable as income by the states. In the above, I did not take that into account. But say, for example, that the $3,500 of interest income above is from a total-bond-market fund, such as the popular Barclay’s Aggregate…in that case, something like 30%–40% of the interest is from Treasuries and the taxable income in each state would be lower by about $1,000. This would have an almost unnoticeable effect in the high-tax states but would make a very measurable difference in the low-tax states.