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Tennessee To Become Income-Tax-Free State No. 8

You retire to an income-tax-free state and you don’t expect to pay any income tax.

So imagine the surprise a former California couple in their 60s got when they went to a tax preparer in Tennessee for help with their 2015 federal tax return, and she gave them the news that they owed $1,200 in taxes to Tennessee on their capital gains, interest and dividend income, thanks to the 6% state “Hall Tax.”

“A lot of seniors come to Tennessee, and they get a surprise: We have a tax on people who have done things correctly by saving for retirement,” says Friday Burke, an enrolled agent in Brentwood, Tenn.

The retired California couple had $125,000 in overall taxable income, including $28,000 in interest, dividends and capital gains, $20,000 of which was subject to the Hall Tax. “That’s $1,200 they hadn’t budgeted,” says Burke.

The good news she was able to deliver to the couple is that the Hall Tax is on its way out.

Tennessee

It was one of a trifecta of taxes that kept Tennessee on the list of states unfriendly to business owners and retirees. The state’s gift tax was repealed effective Jan. 1, 2012.

The state’s estate tax was repealed effective Jan. 1, 2016. And now the Hall Tax is repealed—as of Jan. 1, 2022.

In the meantime, the tax rate was cut from 6% to 5% retroactive to Jan. 1, 2016, and the legislature is meant to decrease the rate one percentage point a year, assuming the state meets certain revenue targets.

“It adds to a positive business climate and appeals to the executives of companies the state is trying to bring in,” says Jamie Yesnowitz, a state and local tax expert with Grant Thornton.

“It will make Tennessee an awesome state,” gushes Burke.

​Tennessee’s move leaves New Hampshire as the only state with a quirky tax on interest and dividends. When the Hall Tax disappears, the state will join 7 other no-income-tax states.

That sounds good, but watch out for other tax gotchas in these income-tax-free states. Tennessee has the highest average combined state-local sales tax rate of all states at 9.46%, according to the Tax Foundation.

You could still be on the hook for the Hall Tax. Some 200,000 Tennesseans paid the Hall Tax in 2014, at an average $1,446 per return (the median was $266). Tax pro Burke guesses there have been more people who should have been paying who haven’t.

The Tennessee Department of Revenue recently started partnering with the Internal Revenue Service to ferret out non-filers.

One new client couple, a hospital executive and his retired wife who had done their own returns previously, brought in an audit “love letter” from the state tax department this year, demanding Hall Tax payments for the last five years to the tune of $655 a year plus interest and penalty charges.

Their federal income varied from $275,000 to $185,000 over the time period.

That puts them squarely in Hall Tax territory. Who’s exempt? If you’re 65 or older and have total income from all sources of $37,000 or less ($68,000 or less for joint filers), you’re completely exempt from the tax.

Separately, there’s a $1,250 exemption per person, so a couple over the income threshold owes Hall Tax only if taxable interest and dividend income exceeds $2,500.

Tennessee Department of Revenue Guidance lists more exclusions, such as interest or dividends from credit unions, dividends from stock in Tennessee chartered state banks.

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