1. State taxes on benefits from retirement plans

Seven states don’t tax individual income at all and therefore don’t tax retirement income either…

• Alaska
• Florida
• Nevada
• South Dakota
• Texas
• Washington
• Wyoming

Two states only tax income from dividends and interest: New Hampshire and Tennessee. So while retirees in these states won’t have to pay taxes on Social Security or pension benefits, they will still owe some taxes to the state if they own dividend-paying stocks or bonds, for example.

n the other 41 states and in Washington, D.C., taxes on Social Security and pension benefits vary. Some states exempt pension benefits or Social Security benefits while other states tax both. For details, check out CCH’s state-by-state breakdown of taxes on pension and Social Security benefits.

2. State income taxes

There are 41 states that tax income, and if you live or plan to retire in one of them, how much of your retirement benefits you could owe depends on that state’s tax rate.

Some states have a relatively low income tax rate across all brackets. The rate for even the highest tax bracket in Arizona, New Mexico, and North Dakota, for example, is less than 5 percent. Some states – for example, Indiana (3.4 percent) and Pennsylvania (3.07 percent) – have a relatively low flat tax rate.

But in other states, income tax is a double whammy: Not only is the tax rate for the highest bracket relatively high, the bar to qualify for the highest bracket is low. In Arkansas, for example, any filer earning $33,200/year pays the highest bracket’s rate of 7 percent. In Maine, couples earning $40,700 and single filers earning $20,350 pay the highest bracket’s rate of 8.5 percent.

For more details on your state or the one you’d like to retire in, check out the state-by-state income tax breakdowns from CCH and the Federation of Tax Administrators.

3. Sales tax

Five states don’t have a sales tax, according to the FTA: Alaska, Delaware, Montana, New Hampshire, and Oregon.

In the other 45 states, the rate varies from 2.9 percent (Colorado) to 7.25 percent (California) – and that’s after California lowered its rate from 8.25 last year.

What types of goods sales tax applies to also varies from state to state. In Hawaii and New Mexico, for example, doctor services are taxed. In South Dakota, accountant and attorney services are taxed. Other goods and services taxed in some states but not others include barber services, landscaping, prescriptions, clothing, and food.

For details, check out the FTA‘s state-by-state breakdown of sales tax rates, which also lists which states exempt food, prescriptions, and over-the-counter meds.

4. State and local property taxes

Because property taxes can be significant, CCH suggests learning not only an area’s current property tax rate, but also the history of how it has changed over time.

To learn more about a state or county, try this search engine formula: [state/county] + state/county property tax. That should lead you to the applicable revenue department’s website. Here’s Florida, for example.

While reading up on a state’s property tax rates, don’t forget to check for tax breaks too. Some states and local jurisdictions offer some form of property tax exemption, credit, abatement, deferral, refund, or other benefit to senior homeowners or renters.

5. State estate tax

Wealthier retirees must also consider the estate tax of the state they’d like to retire in. If that state does tax estates, find out both the tax rate and what size estate the tax applies to.

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“The income tax has made more liars out of the American people than golf has.” – Will Rogers

But what if it were easier? And what if the IRS made it nearly impossible to lie? What then?

Last year, IRS Commissioner Doug Shulman hinted that one way to reduce the potential for tax fraud was to have IRS prepare returns for taxpayers. That’s right, you wouldn’t have to prepare returns come tax time: the IRS would do it for you.

The idea is commonly referred to as a “simple return” or “ready return” (yes, it sounds like a snack you might buy at a Wawa). Under the plan, the IRS would send out tax returns that had already been completed with taxpayer identification and wage information. Taxpayers would merely review the returns for accuracy and sign at the bottom… kind of a “check the box if you agree” system. Taxpayers would have the opportunity to correct any mistakes prior to submitting the returns to the IRS.

Why not? The IRS already has a good chunk of taxpayer information on file. Add to that the obligations of employers, financial institutions and other third parties to provide wage and other income information to the IRS and there’s already a nice little database at the IRS’ disposal.

But putting those returns together is not cheap. Right now, the IRS simply doesn’t have the manpower to prepare returns for taxpayers and pursuant enforcement and collections activities and adding to the rosters (and thus, the budget) would be a major endeavor. Shulman, however, seems to believe that it might be worth considering.

A limited version of the plan is already in place in California. The plan, called (of course), ReadyReturn, is free to taxpayers who qualify in the Golden State. The state uses information from the prior year’s return along with information from the form W-2 to pre-fill a California state tax return. The return only needs to be reviewed by the taxpayer and signed. Brilliant, right? Then how come no one is signing on?

For one, the number of taxpayers who qualify is limited. To qualify, taxpayers must have filed a 2010 California resident return as single or head of household and no more than five dependents. Taxpayers must only have income from wages from a single employer and must claim the standard deduction with no credits other than the renter’s credit. Depending on who you are, the program was either wildly successful or a terrible failure. The pilot program, sent out to 50,000 taxpayers, had a 27% participation rate. That works out to about 13,500 taxpayers. The state has about 20 million taxpayers, making the overall participation rate less than 1/2%. In 2009, the number of participants in the program grew to 60,000 taxpayers, or about 3%. Hardly statistically significant. But the folks who are using the system appear to like it.

The program has also seen success outside of the U.S. Programs in Sweden and Denmark claim participation rates of over 75% (downloads as a pdf). Could the IRS duplicate those kinds of results?

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