The Corrosive Effect of High State Income Tax on the High Income Earning Family

 

One of the joys of making more money is paying more taxes. Before someone chimes in and tells me what a good problem this is – yes, I get it. We are fortunate to make a lot of money and therefore pay a lot of taxes. It beats the alternative. Now with that out of the way, let’s look at today’s topic: the corrosive effect of high state income tax on the high income earning family.

We paid $44,000 in state income tax in 2015 (pre-partner for me at my group) and $58,000 in 2016 (partner for half of the year). I anticipate we will pay greater than $60,000 per year moving forward. To date, this has been offset somewhat by a federal deduction for state income tax for those who itemize their deductions (most of my readers, I would imagine). In 2016, this deduction was by far our largest and worth:

$58,000 x 0.39 (highest fed. tax bracket) = $22,620

This deduction effectively reduces the state income tax for high earners in high income states by 39%. This may be changing soon. Recent discussion of tax reform centers on eliminating the federal deduction for state and local income tax.

I decided to look at the true cost of living in a high income tax state like mine. For simplicity, I will imagine that our state income tax moving forward remains constant at $60,000 per year and that our alternative is living in a state with no tax on wages  (Alaska, Florida, Nevada, South Dakota, Texas, Washington, Wyoming, Tennessee, New Hampshire). I will also assume that tax reform passes and the state tax deduction is eliminated. Of course, this is all overly simplistic to some extent because states with no state income tax tend to have higher property and sales tax. We also may earn more money moving forward so it may in fact be overly conservative.

So let’s say we moved to one of these states and now had $60,000 extra in post tax income to invest in VTSAX earning a conservative annual return of 6%. Where does that leave us after our 25 year careers are up? Here we have it:

Ouch.

Now there are a lot of assumptions at play here, as I alluded to earlier. I am assuming:

  • we would take this extra take home income and be disciplined enough to invest all of it and not grow our lifestyle
  • our savings on state income tax would not be significantly offset by extra costs paid in sales tax or higher property tax, or perhaps even private school.

For high earning couples early in their career and residing in a high income tax state like my wife and I, it is worth considering how strongly you feel about living in one of these states. Naively, we didn’t really run the numbers or consider how much state income taxes would cost us when we were interviewing for our first attending jobs out of residency. Now we are very settled where we live and we have our reasons for loving it here – a great job as a partner in my specialty group; living in a nice part of the country with reasonable weather, limitless outdoor activities, and excellent public schools; family close by. If you don’t have these things tying you to your area (and particularly if the proposed tax reform passes), it may be worth considering a move earlier in your career than later.

 

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Readers, what are your thoughts?