What is Income Tax? How States Without Income Tax Affect You

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In the United States, seven states have no income tax. Another two states don’t tax wages but do tax investment and interest income.

What is income tax and how does it affect you?

Read on for everything you need to know about living in a state without an income tax.

First, What Is Income Tax?

Without money, the federal government can’t operate. How do they “earn” money? Through a tax on income. For the purposes of taxing money, the definition of income varies.

Here are a few things that the government taxes as income, depending on what state you live in:

  • Wages
  • Salaries
  • Interest
  • Dividends
  • Product sales
  • Royalties
  • Winnings from Gambling
  • Rents

Individuals pay most of the above earnings. But businesses and corporations also pay income tax.

How Do You Pay Income Tax?

In states with an income tax, the IRS receives a copy of each individual’s W-2 tax form every year. If you don’t file a return, the IRS calculates what you owe and sends a bill.

Your employer sends you all the information you need for filing income taxes. If you work for yourself, you need to keep track of your income.

Do you need paystubs for yourself or someone who works for you? You can use a company such as The PayStubs.

If you live in a state that doesn’t have an income tax, you’ll pay the federal tax on income but no state tax.

How States Without an Income Tax Affect You

Like the federal government, local governments need money to function. In states without an income tax, the government finds other ways of raising money.

There are several ways states without an income tax do this:

  • Higher property tax
  • Higher gasoline tax
  • Higher sales tax

The lack of income tax affects each individual differently depending on his circumstances.

In the U.S., taxes are progressive. The wealthier you are, the more income tax you pay. That’s because you’re taxed based on a percentage of your income.

If you’re wealthy, living in a state without income taxes is probably a good idea.

If you’re on the low end of the wealth scale, it’s not such a good deal. Why? Because you’ll pay higher property, gasoline, and sales tax.

If your wages are low, you pay less income tax. If your wages are low enough, you pay no income tax no matter what state you live in.

If you’re deciding between a no-income-tax state and one with income tax, look at all the variables.

Is the cost of living much higher in a state with no income tax? Then you might be better off living in a state with a lower cost of living and an income tax.

What State Should You Live In?

Now you’ve got an answer to your question, “What is income tax?” But even in states without an income tax, not everyone fares the same.

When deciding what state to live in, figure out how all the different taxes affect your individual situation. Then go where you feel most comfortable!

Looking for other informative articles? Keep perusing the blog!