Baby Boomers nearing retirement age will have many factors to consider in choosing where to live in retirement, including state taxes, according to CCH tax experts.
“As the economy begins to improve, more retiring baby boomers may begin looking at where they may want to live in retirement,” said CCH state tax analyst Kathleen Thies. “Taxes are one of the things they should consider when determining the costs of different areas they are looking at.”
When evaluating the financial implications of moving, senior citizens should consider the state taxes on retirement benefits; state income tax rates; state and local sales tax, including the growing taxation of services; state and local property taxes; and state estate taxes.
Retirement income is safe from state income taxes in the seven states that do not tax individual income: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Two other states–New Hampshire and Tennessee–impose income taxes only on dividends and interest (5 percent for New Hampshire and 6 percent for Tennessee for 2011).
In the remaining 41 states and the District of Columbia, tax treatment of retirement benefits varies widely as each state generally is allowed to determine its own tax treatment of retirement income, including both pension and Social Security income, CCH noted.
As a result, some states exempt all pension income or all Social Security income, while others provide only partial exemption and others tax all retirement income.
The states that exempt pension income entirely are Pennsylvania and Mississippi. States exempting a portion of pension income include Arkansas, Colorado, Delaware and New York. The states that are generally taxing pension income include Arizona, California, Minnesota and Rhode Island.
Among the states announcing changes to their income taxes for retirement plans in 2011 were:
• District of Columbia: Enacted legislation that amends the income tax withholding rules for retirement distributions. A distribution from a retirement account will be taxed at the highest income tax rate. Imposition of the highest rate is no longer limited to early distributions.
• Georgia: Enacted legislation that phases out the Georgia personal income tax on retirement income beginning in 2012. At that time, taxpayers who are age 62 but under age 65 during any part of the taxable year, or permanently and totally disabled, can exclude up to $35,000 per year for each taxpayer. Taxpayers age 65 or older during any part of the taxable year can exclude up to $65,000 for 2012 ($100,000 for 2013, $150,000 for 2014, $200,000 for 2015) per year for each taxpayer. As of 2016, taxation on retirement income is completely eliminated for taxpayers age 65 or older during any part of the taxable year.
• Michigan: The deduction for pension benefits for senior citizens is curtailed based on the taxpayer's birth year and household resources. Currently, this deduction is limited by a dollar amount, but no other limitation applies. Specifically, for persons born before 1946, the deduction for pension benefits is unchanged. However, for persons born in 1946 through 1952, the deduction for pension benefits is limited to $20,000 for a single return and $40,000 for a joint return, and after that person reaches age 67, the pension benefits deduction is no longer applicable, but the taxpayer is eligible for a deduction of $20,000 for a single return and $40,000 for a joint return against all types of income. For persons born after 1952, when the person reaches age 67, the taxpayer may elect to take the deduction of $20,000 for a single return and $40,000 for a joint return against all types of income and forgo the deduction for Social Security and the personal exemption. Alternatively, persons born after 1952 (after reaching age 67) may elect the Social Security deduction and the personal exemption. For all taxpayers, other than those born before 1946, the available deductions are not available if the taxpayer’s total household resources exceed $75,000 for a single return or $150,000 for a joint return.
• Wisconsin: Updated its guidance on Roth IRA rollovers to conform to the federal treatment. Federally, taxpayers who rolled over a regular IRA to a Roth IRA in 2010 had the option of paying all the income tax owed on their 2010 income tax return, or paying it in two even installments on their 2011 and 2012 tax returns. Note, for Wisconsin’s purposes a taxpayer paying the taxes on their 2011 and 2012 tax returns is required to pay Wisconsin the tax on the distribution for each of the two years, even if the taxpayer becomes a nonresident of Wisconsin during the two-year period.
While some states tax pension benefits, only 14 states impose a tax on Social Security income: Colorado, Connecticut, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, New Hampshire, New Jersey, North Dakota, Rhode Island, Vermont and West Virginia. These states either tax Social Security income to the same extent that the federal government does or provide breaks for Social Security income, often for lower-income individuals.
According to Thies, one struggle for many seniors in 2011 continued to be that few states increased their exemption thresholds for Social Security income tax.
“States continued to have serious revenue shortfalls, so many again did not increase Social Security exemption thresholds,” she said. “However, after two years without an inflation adjustment, some relief will be provided by the cost of living adjustment for Social Security benefits at the federal level for 2012.”
State Income Tax Rates Also Vary Widely
Income tax rates also can have a significant financial impact on retirees in determining where they want to live and can vary widely across the country.
While only a few states have no income tax or only tax interest and dividend income, as noted above, some have a relatively low income tax rate across all income levels. For example, the highest marginal income tax rates in Arizona, New Mexico and North Dakota are below 5 percent. Some states have a relatively low flat tax regardless of income, such as Indiana (3.4 percent) and Pennsylvania (3.07 percent) for 2012.
On the other hand, some states have much higher income tax rates on more modest income. For example, in Maine, the highest tax rate of 8.5 percent applies to income of more than $40,700 for couples and $20,350 for single filers in 2012 and in Arkansas the highest rate of 7 percent applies to income of more than $33,200 regardless of filing status. A few states have very high income tax rates for wealthier taxpayers. For example, Oregon has a maximum 11 percent income tax rate for income of more than $500,000 for couples and $250,000 for single filers.
“States have not been as aggressive in raising income taxes overall, despite the struggling economy,” said Thies. “However, retirees need to understand that states can do this and should research the tax climate in areas they’re looking at so they aren’t surprised once they’ve moved.”
Property, Sales Tax Add to Tax Burden
Property and sales tax also can affect the affordability of retirement living. Both property tax and sales tax can include a state component as well as a county, city or other local taxing body component in most parts of the country, making them potentially more volatile.
Sales and Use Tax
Sales taxes vary considerably state to state and local taxes can also add significantly to the tax rate. In 2011, Connecticut increased its state sales and use tax rate from 6 percent to 6.35 percent effective July 1, 2011. A few states also decreased their state rates: California, from 8.25 percent to 7.25 percent effective July 1, 2011; and North Carolina, from 5.75 percent to 4.75 percent, also effective July 1, 2011.
Local sales and use tax rates also have an effect on the total rate, so retirees need to keep those in mind as well.
In addition to knowing the sales tax rates, it’s important to know where and to what extent they apply.
“States are struggling to deal with their budget deficits and are constantly looking for ways to increase their revenues,” said CCH senior state tax analyst Carol Kokinis-Graves. “Yet, state legislatures are often reluctant to impose an across-the-board rate increase, and may opt instead to apply the sales tax to a broader range of transactions.”
To this end, states often consider taxing services as a way to meet their revenue requirements without technically raising the base sales tax. It also can have an impact on what seniors can expect to pay for everyday services.
For example, only Hawaii and New Mexico tax services provided by a doctor; these states, as well as South Dakota also tax services provided by CPAs and attorneys.
However, more everyday services also are taxed in some states. For example, Hawaii, New Mexico and South Dakota, as well as Iowa, tax barber services. And many states assess taxes to some extent on landscape services, including Arkansas, Arizona, Connecticut, District of Columbia, Hawaii, Iowa, Minnesota, Mississippi, Nebraska, New Jersey, New Mexico, New York, Ohio, Pennsylvania, South Dakota, Texas, Washington, West Virginia and Wisconsin.
How states tax other consumer goods also varies considerably. For example, with the exception of Illinois, all states exclude prescription drugs from sales tax. Massachusetts, Minnesota, New Jersey, Pennsylvania, Rhode Island and Vermont all exclude some clothing from tax. Some states also exempt certain food from tax.
Property Tax
While property taxes can be significant, seniors may be able to take advantage of property tax breaks.
For example, many states and some local jurisdictions offer some form of property tax exemption, credit, abatement, tax deferral, refund or other benefit to senior citizen homeowners. These tax breaks also are available to renters in some jurisdictions. The benefits typically have qualifying restrictions that include age of the homeowner and their income.
Because property taxes can be a significant expenditure, it’s a good idea to clearly understand not only the current property tax but also the history of how property rates have changed in the area.
State Estate Tax Treatment Also a Consideration
For wealthier seniors, state estate taxes also can have an impact on where they choose to call home.
Seniors need to check whether or not and to what extent the state assesses an estate tax. They also need to consider on what size estates any taxes kick in as many states impose estate taxes on much smaller estates than under federal law.
“States are cash strapped, so many have an exclusion amount of $1 million or $2 million and are reluctant to raise the exclusion amounts,” said CCH estate planning analyst James C. Walschlager.
