Big changes for state tax laws

By Catherine Holahan

Think millionaires are the only folks facing tax hikes this year and next? Think again. At least half a dozen states raised income tax rates for their highest earners this year. In many cases, the increases affect employees earning $150,000 or less annually.

"I wish we had a better term for these taxes than millionaire taxes because the threshold in which they kick in keeps dipping lower and lower," said Joseph Henchman, tax counsel at the Tax Foundation, a nonprofit taxpayer group that monitors federal, state and local levies.

The Tax Foundation released its first midyear analysis on state taxes July 29. The organization typically publishes annual reports. This year, however, the organization released an early review due to the large number of states that have changed their tax codes in the past several months.

Income taxes by state

States are overhauling their tax systems in an attempt to bridge massive budget gaps. High unemployment, combined with plummeting property values, last year's stock market declines and reduced consumer spending, has left many states facing revenue shortfalls of crisis proportions. Receipts from income taxes on income, property, sales and capital gains have fallen drastically for many states.

"Obviously states have been having trouble trying to balance their budgets right now," said Mark Robyn, a staff economist at the Tax Foundation.

The most high-profile example is California. The state faced a $24 billion budget deficit. Earlier this week, California Gov. Arnold Schwarzenegger cut spending by $16.1 billion in order to balance the state budget and stop issuing IOUs to vendors. Five months ago, the state also raised income taxes for all brackets by 0.25 percentage points, retroactive to the start of the year.

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California is far from the only state to raise income taxes to balance the budget. Hawaii, New York, Delaware, New Jersey, Oregon and Wisconsin all raised taxes on workers in the top income brackets.

• Hawaii: The state added three new income tax brackets in May. Before the changes, the state levied an 8.25% tax on all income above $48,000 a year. Under the new rules, which are retroactive to Jan. 1, income of $150,000 or more is taxed at 9%. Wages greater than $175,000 are taxed at 10%. Incomes of $200,000 or more are taxed at 11%.

• New York: The Empire State raised taxes on earners making $200,000 a year or more. Workers earning $200K saw their state taxes increase from 6.85% to 7.85%. Workers earning $500K per year saw an even greater increase, from 6.85% to 8.97%. The new rates are retroactive to the start of the year and are intended to last three years. They do not include local taxes. Cities such as New York City charge heads of households as much as 3.2% on all annual income over $60,000.

• Delaware: This state increased its top income tax rate a percentage point to 6.95% in July. The new rate, which impacts those earning more than $60,000 a year, is expected to take effect Jan. 1, 2010.

• New Jersey: The Garden State levies the highest property taxes in the nation. The state now also has the distinction of being one of the most expensive places for "millionaires" to live in terms of income tax. The state added three new tax brackets this year for earners making $400,000 or more. The income tax rate for employees earning $400,000 jumped to 8% from 6.37%. Those earning $500,000 will pay 10.25%. Workers making seven figures or more will pay an income tax rate of 10.75% on every dollar at or above the $1 million mark. The new tax rates are intended only for the 2009 tax year and are retroactive to Jan 1.

• Oregon: This state adopted two new brackets for top earners. Now, residents earning more than $125,000 will pay 10.8% instead of 9%. Those earning more than $250,000 will pay 11%. The new rates apply to tax years after Jan. 1, 2009, and before Jan. 1, 2012. In 2012, the state plans to reduce the 10.8% rate to 9.9%. The impact of the hikes may not be as bad as it first appears, however, since Oregon does allow residents to deduct federal taxes from their state taxes.

• Wisconsin: In June, the state added a new tax bracket for people earning more than $225,000 a year. The tax rate on these earners rose from 6.75% to 7.75%.

The state tax hikes combined with proposed federal increases on high-income workers may effectively raise the marginal tax rate well above 50% for those in the top brackets. In states with "millionaire taxes," many may see their taxes jump to 55%.

Continued: Taxing high earners may backfire

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