State income taxes: Everything you need to know

State income tax is an additional tax payment that millions of Americans must file along with federal income tax every year. 

The annual tax rate often differs from state to state, and there is a 0% income tax rate in some states. Other states, such as New Hampshire, only taxes its residents on dividend and interest taxes.

Eight states in the nation do not charge taxpayers for personal income tax. State taxes are often based on geography and socio-economics and depend on which political party is in power.

What is state income tax?

Outside the federal income tax to which all American taxpayers must adhere, most individuals also have to pay income tax based on the state where they live. State income tax is a direct tax of an individual's income in the state where they earned their annual income.

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Moreover, individuals may face additional taxes based on the municipality or city where the address is located. However, state income tax is common in 42 U.S. states and Washington, D.C.

In addition, most state income taxes vary in proportion and regulation across the country. Individuals must file a state tax return in the states where they earn income, but only their home state is capable of taxing all of their income.

Why do taxes vary state by state? 

Although states receive federal funding for a variety of public projects and welfare programs, each state must rely on income produced from individuals and sales that fund the annual budget to construct roads and education facilities. State income and sales taxes vary by state based on a number of factors, including the average income of its citizens. States such as California have a higher income level and, therefore, have heavier income and sales taxes, whereas states with less centralized wealth, such as Kansas, have lower tax rates.

Other taxes are also subject to the internal laws and regulations of each state, such as gas taxes, alcohol taxes, tobacco taxes, licenses and toll fees.

Why do taxes vary city by city in each state?

Geography is one of the most important factors in states where each city's sales taxes and other government-levied fees differ. For example, New York City is one of the biggest urban centers in the country and is the financial center of the United States. Therefore, New York City will have a higher sales tax than Albany County, which has a significantly lower population and average income bracket. 

In addition, cities with large amounts of annual tourism and that are located along the coast will generally have higher taxes than inland cities with fewer tourist attractions.

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Which states have the highest tax rates?

Over the last few years, the states with the highest taxes have consistently remained the same, with California as the top-taxed state at 12.3% and more than 13% for taxpayers with an annual income of more than $1 million. The top states with the highest tax rates include California, Hawaii at 11%, New Jersey at 10.75%, Oregon at 9.9%, Minnesota at 9.85%, New York at 8.82%, Vermont at 8.75%, Iowa at 8.53% and Wisconsin at 7.65%.

Which states have the lowest tax rates? 

Meanwhile, there are only eight states in the country that do not have a personal income tax for its taxpayers, and thus have the lowest in the nation. These states include Wyoming, Washington, Texas, South Dakota, Alaska, Nevada, Florida and Tennessee. 

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Also, states such as New Hampshire only have interest and dividend teases, not direct income tax from an individual personal annual wage, and Pennsylvania has a flat tax rate of 3.07%, making it one of the lowest tax rates in the nation.