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How State Income Taxes Work

        Money | Taxes

Tax-free States

Currently, there are seven states that do not have an individual income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Two additional states -- New Hampshire and Tennessee -- only charge tax on interest earnings and dividends from owning stock, so essentially, they have no income tax.

How do these states get enough money to operate their governments without an individual income tax? When it comes to taxes, each state has to look at its assets and consider what taxes would bring in the revenue it needs. In some cases, charging an income tax is not as useful as charging other types of taxes.

Take Wyoming as an example. Wyoming has a population of only slightly more than half a million people. With a population that small, relying on a personal income tax just wouldn't bring in enough money for the state government to run itself. But what Wyoming does have is natural resources, so it's not surprising that two of the state's largest revenue sources are severance taxes (taxes on the removal of natural resources) and mineral royalty taxes (a tax on revenue earned from selling minerals from the state). Plus, with a small population and a lot of open land, Wyoming doesn't need as many government services, like highways and hospitals, so the state can easily survive without charging an income tax.

Another good example is the state of Nevada. Like Wyoming, Nevada does not have a personal income tax. Instead, the two largest sources of revenue for the state are sales taxes and gaming (gambling) taxes. This is not surprising since Nevada casinos are a popular tourist destination.

Because each state is different -- each has a different population, different resources, different potential sources of income and different needs -- it's left up to each state to decide how best to generate its own revenue. If each state was limited to bringing in, say, a 5 percent flat tax on income, states like Wyoming and Alaska (which have small populations) would probably not bring in enough money to function properly.

So, how and when are you expected to pay state income taxes? Keep reading to find out how the money gets from your bank account to the government's hands.


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