Choosing a State for Residency Merely Because There is No Income Tax May Not be Smart!

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There is much more to consider in the tax area than only state Income Tax.

It appears that many folks have made major plans depending on the Income Tax that is levied by a given state of residency.

It is well worth the effort to consider the state income tax, along with the other issues that should impact the decision to choose one state to reside in as opposed to another.

There is no question that there are many issues that supersede the fact of income tax when choosing a place to reside.  There are the myriad personal issues that rightfully influence the decision to reside in one state over another.  There are family issues, friends to consider, employment opportunities, medical issues, weather preferences, other financial issues, health, other opportunities, and much more to examine when selecting a home state.

However, if we focus on only the state tax issue, we are being short sighted, even on the tax issue.  There is merit to weigh more than the reference to state Income tax concerns.  Many folks choose a place of residence by looking only to the tax issue-- by considering if the state Income tax is lower or higher in the states that are being considered for residency.

 Income taxes are one of the largest taxes that are normally paid by a taxpayer.  Thus, directing attention to this issue makes good sense.

On the other hand, it is reasonable for the given taxpayer/resident to stop and weigh other taxes, without assuming the income tax is the controlling tax of interest.   I have seen numerous citizens focus, when considering the tax issue, by looking only at state Income tax, concluding that leaving one state that has a high-income tax for another state with no income tax is an intelligent move, regardless of other tax issues.

Consider that there are many other taxes on the state level.  There are transfer taxes, alternative minimum tax issues, excise taxes, resort taxes, other fees/taxes, transfer taxes, gift taxes, estate taxes, inheritance taxes, and many other forms of taxation in many states.

When some residents announce to family and friends that they are relocating to a given state which has no state income tax, there seems to be a tendency for listeners to direct their attention to this one issue, viz., state Income taxes.

When examining other taxes, without focusing for the moment on state income taxes, consider the estate tax or the state inheritance tax that might exist in a given state.

On the Federal level, if one exceeds their lifetime gift and estate unified exemption of $15,000, 000 for each person (as of 2026), absent other exemptions, the tax rate on the estate for assets in excess of the exemption is huge!  Such estate, in the setting noted, is taxed at 40% for the taxable estate in which exceeds the exemption noted.  What?!  40%! 

This rate should encourage all citizens that have larger estates to avoid the Federal estate tax, legally.  That is, there are proper approaches to planning to try to avoid or lessen the estate tax burden on the Federal level.

When looking to a given state, it is reasonable for a taxpayer to ask: “Does the state have an estate tax?”  If so, additional questions should be asked as to any exemptions, what the rate of tax is, and how one can legally avoid or reduce the state tax. 

Some states also have an inheritance tax.  Often the distinction of estate or inheritance tax is based on who is paying the same for the levied tax.  If the tax falls on the estate, it normally is labelled an estate tax.  If the tax falls on the beneficiary, it is often labelled an inheritance tax.  The important point for this discussion is to determine what taxes exist at the state level where one resides and where one is considering to possibly reside.

Some states have small exemptions and then levy an estate and/or inheritance tax of anywhere from a very small amount to the high side of about 16%. 

Because of the large Federal exemption of 15 million per taxpayer, most estates will not have a Federal estate or gift tax.  However, the state where the decedent resided could have a substantial estate/inheritance tax.  That is, there could be a small exemption, say 5 million, and then a tax on the amount of the estate that exceeds the exemption. Assume for this example that the rate is 8%.  If this setting took place and the estate of the decedent for example was 15 million, there would not be any Federal estate tax, but there could be a state tax, in the example noted, of $800,00.  That is 15 million reduced by the 5 million exemption, resulting in 10 million taxed at 8%.

The moral of the story is clear:

Even if one looked only at the tax issue when selecting a state of residency, this could be an important consideration where there are state taxes to consider—even those beyond an income tax that might not even be applicable in some states, such as Florida, Texas, Nevada, etc.

As stated, the tax issue will not be the controlling issue for most residents when choosing a state for residency.  However, taxes are important.  When considering this factor, look to more than the income tax of the given state.

By

Dr. Mark Lee Levine, Professor, University of Denver