The tax friendliest places to live in the US

There are many reasons residents choose to live in a particular area. It could be the warm climate, exceptional school systems, or enjoyable nightlife, but many don't ask the question, how "tax-friendly" is the area in which they live? That is why the Tax Foundation, a policy research group, ranks each of the 50 states and the District of Columbia to find the tax-friendliest place to live. This study is based on what residents pay in various taxes, including state and local income taxes, property taxes, sales taxes, luxury and fuel taxes. So, where does your state rank?

And the winner is...

As in years past, Alaska was voted the most tax-friendly state for 2005. Not only does Alaska not impose any state sales tax or income tax. The Alaskan government actually pays its residents a refund each year because of the excess revenue collected from companies extracting oil from the state.

New Hampshire and Delaware took second and third in the tax-friendly rankings. Like Alaska, New Hampshire does not impose sales tax nor does it tax wages (although it does tax investment income). Delaware's lack of sales tax helped it rank third, as well as its low income taxes (the top rate is 5.95%) and small burden imposed on residents resulting from the state's corporate tax.

Now for the unfriendly

The residents of Maine may be surprised to learn that their state ranked number one as the least tax-friendly place to live. Although Maine is one of the lowest income states in the country, it carries the highest rank in terms of tax collection. Property taxes account for about 40% of the overall tax revenue collected, and it has somewhat high income tax rates—a top rate of 8.5% for all income above $16,950.

The District of Columbia ranked second, partly because of the high individual income tax —the top rate is 9.3% for income above $30,000. Coming in third, New York maintained its usual high ranking due to its above average sales tax of about 8%, plus the option to levy a local income tax.

How can I tell if I'm living in an unfriendly state?

The Tax Foundation created its list by measuring, as a percentage of per capita income, what residents paid in income, property, sales and other personal taxes charged at the state and local levels. However, because the Tax Foundation's list is based on general estimates, how tax friendly your state is to you could depend on your particular lifestyle. The following taxes can be reviewed individually to see how tax-friendly your state is to you:

Personal income tax

Forty-one states impose a personal income tax. New Hampshire and Tennessee apply it only to income from interest and dividends, which means those residents who have investments may pay a heftier personal income tax. Seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) do not tax personal income.

Sales tax

All states except Alaska, Delaware, Montana, New Hampshire, and Oregon, collect sales tax. Some have a single rate throughout the state, while others permit local additions to the base tax rate. For example, the sales tax is 6% in most of Pennsylvania, but 7% in the big city Allegheny (Pittsburgh area) and Philadelphia counties.

Property taxes

Property tax is the biggest source of revenue for local governments, and many times a state with reasonable taxes may have high property taxes. Although New Hampshire ranked second of the most tax-friendly states, the area has relatively high property taxes. Where you live in the state may affect your property taxes. Owning a home in a highly attractive neighborhood would most likely increase your property tax, and rural areas tend to have lower tax rates than big cities. However, you may still find tax breaks depending on which state you reside. All 50 states offer some type of property tax relief program, and counties and municipalities often have their own property tax relief programs.

Cigarette tax

If you are a smoker, you have probably come to realize the continuous rise in cigarettes. This is because several states continue to raise excise taxes on cigarettes and other tobacco products in order to increase revenue. In 2004, Alabama, Alaska, New Jersey, and Virginia raised cigarette taxes. Counties and cities may impose an additional tax ranging from 1 cent to $1.50 on a pack of cigarettes in Alabama, Illinois, Missouri, New York, Tennessee, and Virginia. In addition, on July 1, 2005, Hawaii and Virginia will raise their cigarette tax by 30 cents.

Fuel tax

Driving has become more and more expensive as gas prices continue to rise. Every state collects tax on fuel. In addition, nine states permit cities or counties to impose a local tax on fuel. Taxes in some states can also vary based on the wholesale price, which is adjusted quarterly.

Retirement income taxes

Only 26 states refrain from taxing Social Security benefits. Kansas, Minnesota, Missouri, Nebraska, North Dakota, Rhode Island, and Vermont tax Social Security to the extent it is taxed by the federal government. Connecticut, Iowa, Montana, and Wisconsin tax Social Security income above an income floor.