How to Lower Your State Taxes With Key Strategies

State governments levy taxes on income to fund public services and infrastructure. While often discussed together, federal and state tax systems are distinct, each with its own set of rules and rates. Each state has the authority to design its own tax structure, leading to significant variation. Some states implement a progressive tax system where higher levels of income are taxed at higher rates, while others use a flat tax. A handful of states do not levy a personal income tax at all.

Adjusting Your Taxable Income

A primary method for lowering your state tax bill is to reduce your taxable income, as many states begin their calculation with the federal adjusted gross income (AGI). Consequently, strategies that lower your federal AGI often have a direct impact on your state tax return. One common approach involves contributing to tax-deferred retirement accounts, which decreases the income subject to state taxation.

Contributions to traditional 401(k) plans are made with pre-tax dollars, lowering your reported income for both federal and state purposes. For the 2025 tax year, the maximum individual contribution to a 401(k) is $23,500. Those age 50 and over can make an additional catch-up contribution of $7,500, but individuals aged 60 to 63 are eligible for a higher catch-up of up to $11,250. Similarly, contributions to a traditional Individual Retirement Arrangement (IRA) can be deductible, though deductibility depends on your income level and whether you are covered by a workplace retirement plan.

Health Savings Accounts (HSAs) offer another way to reduce state taxable income. To be eligible, you must be enrolled in a high-deductible health plan (HDHP). Contributions to an HSA are federally tax-deductible, and most states conform to this rule, allowing you to deduct contributions on your state return. However, a few states do not follow federal guidelines and may tax HSA contributions and earnings.

Investing in a 529 college savings plan can also provide a state tax advantage. While contributions are not deductible on your federal return, more than 30 states offer a state income tax deduction or credit for contributions to their own state-sponsored 529 plan. The specifics of these benefits, including deduction limits, vary by state. A smaller number of “tax parity” states allow a deduction for contributions to any state’s 529 plan.

Utilizing State Tax Deductions and Credits

After determining your adjusted gross income, deductions and credits further reduce your tax liability. Taxpayers must choose between taking a standard deduction or itemizing deductions. The standard deduction is a fixed dollar amount that varies by filing status, while itemizing involves tallying up specific eligible expenses. The better choice is whichever results in a larger reduction of your taxable income.

State standard deduction amounts are not uniform and often differ from the federal amount. If your total eligible itemized deductions exceed your state’s standard deduction amount, itemizing is the more advantageous path. This requires careful record-keeping of all qualifying expenses.

Common itemized deductions at the state level often mirror federal deductions, though rules and limitations can vary. These include deductions for home mortgage interest, charitable contributions, and medical expenses that exceed a certain percentage of your AGI. Many states also allow a deduction for state and local taxes (SALT) paid. The federal SALT deduction is capped at $10,000 for most filers, a limitation that some states do not follow on their own returns.

Tax credits provide a dollar-for-dollar reduction of your actual tax bill, unlike deductions, which only lower your taxable income. States offer a wide array of credits, and their availability depends on the laws of your state. Common examples include credits for child and dependent care expenses, education expenses like college tuition, and incentives for environmentally friendly actions like installing clean energy equipment.

Managing Investment and Business Taxes

For individuals with investment portfolios or business ownership, specific strategies can help manage state tax liabilities. These methods go beyond standard income adjustments and deductions, targeting taxes on capital gains and business profits.

A widely used strategy for investors is tax-loss harvesting. This involves selling investments at a loss to offset capital gains realized from selling other investments at a profit, reducing the total amount of capital gains subject to state taxes. If your losses exceed your gains in a given year, federal rules allow you to deduct up to $3,000 of the excess loss against your ordinary income, a provision that many states also follow. Any remaining losses can be carried forward to offset gains in future years.

Owners of pass-through businesses, such as S-corporations and partnerships, may utilize a Pass-Through Entity (PTE) tax. This is a workaround to the $10,000 federal SALT deduction cap adopted by more than 30 states. Under this structure, the business elects to pay state income tax at the entity level, which is fully deductible for federal tax purposes. The owners then receive a credit on their personal state income tax returns for the taxes paid by the entity, bypassing the federal limitation.

The legal structure of a business also has state tax implications. Sole proprietorships and partnerships are pass-through entities, where profits are taxed at the owner’s personal income tax rate. In contrast, a C-corporation is subject to a state’s corporate income tax. Forming an LLC and being taxed as an S-corporation can offer advantages by changing how income is taxed, though some states impose entity-level taxes on S-corps.

Relocation and Residency Considerations

A taxpayer’s physical location is a factor in determining their state tax obligations. Moving to a state with a more favorable tax structure is a significant strategy for reducing one’s tax burden.

As of 2025, nine states do not levy a personal income tax:

• Alaska
• Florida
• Nevada
• New Hampshire
• South Dakota
• Tennessee
• Texas
• Washington
• Wyoming

Washington, however, imposes a 7% tax on the sale of long-term capital assets on gains exceeding an annual standard deduction.

Simply owning property in a low-tax state is not enough; you must legally establish “domicile” there. Domicile is your true, permanent home, and the place you intend to return to. State tax agencies are rigorous in verifying a change of domicile, and the burden of proof falls on the taxpayer. Actions to establish domicile include:

• Obtaining a new driver’s license
• Registering your vehicles in the new state
• Registering to vote in the new state
• Updating your mailing address for all financial accounts and legal documents
• Opening new bank accounts
• Filing a final resident tax return in your former state

States have rules for taxing individuals who move during the year. If you move from one state to another, you are considered a part-year resident in both states. You will file a tax return in each, paying tax on the income you earned while residing in that specific state.

Nonresident rules apply when you live in one state but earn income in another. You must file a nonresident tax return in the state where the income was earned and pay tax on that specific income. Your home state will also tax that same income but will provide a tax credit for the taxes you paid to the nonresident state to prevent double taxation.