Building on our previous discussions on Federal Taxes, we now explore the other tax regime that greatly impacts you—state taxes.
“Discipline is the foundation upon which all success is built. Lack of discipline inevitably leads to failure in managing your finances.” – Jim Rohn
Many of us anxiously await the filing of taxes in April each year. Some of us are eager to collect our refunds, others are filled with the ominous feeling of knowing we will owe more. Most taxpayers, however, focus largely on the Federal tax system, which the IRS oversees, and do not consider the degree to which state taxes will impact your overall tax burden.
Do not make this mistake! For some taxpayers, state taxes may be sizeable, and they may impact your planning strategies. It’s impossible to successfully manage your overall finances without understanding and planning effectively for them.
In this Stack I will list and explain the taxes states may impose—including income, property, sales, and capital gains taxes. I will then explain the relationship between state and federal taxes and how state taxes may impact your federal tax liabilities. Finally, I will emphasize the importance of understanding these concepts and how doing so will assist not just in your near-term financial planning but also for your long-term life goals.
By the end of this Stack you will not be a state tax expert, but you will understand what aspects of your state tax code you need to educate yourself in. I will give you the tools to better understand how where you live directly affects what taxes you owe both to your state and to the federal government.
Understanding Types of State Taxes
There are several types of state taxes that will impact your bottom line.
Income Tax
Taxes on your earnings will vary depending on your state. Some states have a progressive tax system (like the Federal government), meaning tax rates increase as a taxpayer’s income increases. Other states have a flat tax system, where everyone pays the same rate regardless of their income.
The Tax Foundation is an excellent resource if you want to find out if your state has income tax, what type it is, and the rates. State Individual Income Tax Rates and Brackets | Tax Foundation.
Property Taxes
Property taxes exist in every state in the United States. They are a major source of revenue for state and local governments and are used to fund public services such as schools, roads, and public safety.
The specific rules and regulations regarding property taxes can vary by state and even by local jurisdiction, but the amount due will be based on the value of you real estate.
Sales Tax
Sales tax is a tax on the sale of goods and services that is imposed by state and local governments. The tax is usually a percentage of the sales price of the item or service, and the rate can vary depending on the state and locality.
Capital Gains Tax
Some states impose a capital gains tax in addition to the federal capital gains tax. Just as with income tax, these tax rates vary by state, but are very important to know, especially if you are making large transactions in your state such as buying and selling real estate.
How State Taxes Can Lower the Amount You Owe the Federal Government
Some good news for taxpayers who itemize their deductions: the income, property, and sales tax you pay to your state is deductible against your federal taxable income and can help reduce it. However, this does not include any capital gains taxes you pay to your state—those are not deductible.
For taxpayers who itemize their deductions (for more information on itemizing—review our Stack focusing on Federal taxes), you can claim income tax paid to your state as a deduction against your federal taxes. Until 2025, however, the state income tax deduction is subject to certain limitations and total state and local tax deductions (including income, property, and sales taxes) is capped at $10,000.
Example, limit does not apply: A taxpayer earns $50,000 and paid $2,000 in state income taxes. If they itemize their deductions when they file their federal tax return, they can claim a deduction for the $2,000 in state taxes paid. This reduces their taxable income for federal tax purposes to $48,000 ($50,000 – $2,000).
Example, $10,000 limit applied: A taxpayer earns $100,000 and paid $25,000 in state taxes (income, property, and sales tax). If they itemize their deductions when they file their federal tax return they can claim a deduction for up to $10,000 in the total state taxes paid. This will reduce their taxable income for federal tax purposes but not by the total $25,000, since you can only deduct up to $10,000. Therefore, this will reduce the tax payers federal taxable income to $90,000 ($100,000 – $10,000).
Why You Must Understand State Taxes
Understanding what taxes you will be obligated to pay your state, and how they impact your federal tax return, will help you navigate your finances by preparing you for the amount you may owe in taxes. But it may also affect your long-term strategy on how you negotiate with employers or how you pay yourself, or even where you decide to live.
Guides You In Compensation Negotiations and Decisions
If you are a W-2 employee, being aware of how taxes impact your take-home pay will help you negotiate your salary or compensation package to benefit your circumstances. For instance, it helps you compare the net income you would receive from different offers in different states—or even how a differently structured compensation package from the same employer could reduce your end-of-year tax bill.
If you are self-employed, your state income tax rates may impact what type of business entity you form (S-Corp, LLC, etc.) and how you pay yourself from that entity. (If your business is already formed, be sure to consult with your tax attorney before deciding to change your business structure.)
Understanding the impact of your state on your income tax bill can help you make informed decisions to minimize your tax liability, whether self-employed or a wage earner.
Reduces Anxiety
Of all the financial things that give my clients anxiety, taxes are far and away the largest trigger. In particular, clients who live in high-income tax states that also impose capital gains taxes on large transactions are constantly surprised about their tax obligations.
Really understanding the cost of taxes in your state might not be pleasant, but by doing so, you face reality and avoid surprises during tax season that may leave you scrambling for resources to pay them. Facing the music on state taxes enables you to better manage your finances and make more informed long-term financial decisions.
Guides You in Long-Term Location Decisions
In recent years, the number of people relocating between states has reached a record high following the rapid shift to remote work for many jobs. People are choosing to move for a variety of reasons, but one significant driver is the cost of living, and in particular, the tax regime of different municipalities and states.
For my clients residing in high-tax states, some are planning to move in retirement to reduce taxes, while others prioritize their stability and current quality of life and accept the additional tax burden. Ultimately, there is no right or wrong decision as it depends on your financial goals and lifestyle preferences. What is crucial, though, is to understand how taxes can affect your current situation and long-term financial success so you can make informed decisions about how you live your life.
Discipline & Your Taxes
There is no drier area in finances than taxes. With the exception of a few accountants I know who greatly enjoy it, as a rule, many of us avoid understanding it well and rely on someone else or a software to manage it for us.
While I urge you to hire a professional to prepare your taxes—particularly if you own real estate—it is essential that you do not outsource understanding the broader implications of how taxes will affect you. Part of a disciplined approach to finances is to educate yourself in the areas that will impact you directly. Taxes are by far the biggest arbiter of wealth in America—so spend the time and resources to understand their direct impact on you.