As state governments struggle with budget shortfalls, finding tax breaks for seniors is becoming more and more of a moving target. Some states are eliminating the tax incentives they’ve used for years to lure retirees. For example, while Michigan fully exempts Social Security, starting in 2020 some taxpayers born after 1952 will be taxed on their Social Security benefits. Knowing which tax breaks work best for you depends on your situation -- for example, if you'll rely on a pension during retirement rather than on dividends and interest.
First off, you might want to look for a state with no income tax. It’s a short list: Only Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming have no income tax. Tennessee and New Hampshire tax only dividends and interest. But the lack of a state income tax doesn’t necessarily mean a low overall tax burden. States raise revenue in a variety of ways, including sales taxes, excise taxes, and property taxes -- as well as estate and inheritance taxes.
Ten states exclude all federal, state and local government pension income from taxation: Alabama, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Mississippi, New York and Pennsylvania -- though they may tax out-of-state government pensions. By the way, states are prohibited from taxing benefits of U.S. military retirees if they exempt the pensions of state and local government retirees.
Twenty-seven states and the District of Columbia exclude Social Security benefits from state income taxes. They are Alabama, Arizona, Arkansas, California, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia and Wisconsin. In Colorado, Social Security is not exempt, but benefits can qualify for the state's retirement income exclusion, which is worth up to $24,000.
Overall Tax Burden
Perhaps the most effective way of determining the states with the best tax breaks for seniors is by determining the overall tax burden. Calculated by the Tax Foundation of Washington, D.C., this report measures the percentage of income that taxpayers pay in state and local taxes. Every tax collected on both the state and local level is considered: income taxes, sales taxes, property taxes and more. According to 2010 data, the states with the lowest state and local taxes are Alaska, South Dakota, Tennessee, Louisiana and Wyoming.
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