State Income Tax and Military Pay: Save $3,000-$8,000 Annually

Where you claim legal residence as a military member determines whether you pay state income tax on your military pay—potentially $3,000-$8,000 or more in annual tax savings. Yet many service members establish residency in high-tax states by default, losing thousands in lifetime earnings to unnecessary state taxes.

Understanding military-specific state tax rules, strategically establishing residency, and maintaining it correctly throughout your career can save $100,000-$250,000 over a 20-30 year military career. Here’s how to legally minimize or eliminate state income tax on military compensation.

Military Residency Rules: Different From Civilians

Civilians establish state residency based on where they physically live and work. Military members have special protections:

Soldiers’ and Sailors’ Civil Relief Act (SSCRA) and Military Spouses Residency Relief Act (MSRRA): Allow service members and spouses to maintain legal residence in one state while stationed elsewhere for military orders.

This means you can:

Claim residency in Florida (no income tax)
Be stationed in California (13.3% income tax)
Pay ZERO California state income tax on military pay

Critical Point: Your Home of Record (enlisted) or State Entered Service (officer) on your enlistment/commission paperwork does NOT determine tax residency. You can change legal residence during your career to minimize taxes.

States With No Income Tax (Top Choices for Military Residency)

Nine states have no state income tax on wages:

Alaska
Florida
Nevada
New Hampshire (taxes dividends/interest only, not wages)
South Dakota
Tennessee
Texas
Washington
Wyoming

Annual Savings Example – E-6 with 10 Years:

Base Pay: $47,112
California Tax (9.3% bracket): $4,381/year
Texas Tax: $0
Annual Savings: $4,381
Over 20-year career: $87,620 saved

States Offering Full or Partial Military Pay Exemptions

Several states with income taxes exempt military pay partially or fully:

States with Full Military Pay Exemption

Illinois: All military pay exempt while on active duty

Reason to consider: If you have civilian spouse working in Illinois, establishing Illinois residency exempts your military pay while spouse’s income is taxed normally.

States with Partial Military Pay Exemptions

Arizona: Up to $3,500 annual exemption

Indiana: Up to $5,000 annually

Massachusetts: Military pay while stationed outside MA is tax-free

North Carolina: Up to $4,000 annually

Pennsylvania: Full exemption for military pay (one of best tax states for military)

Virginia: Up to $15,000 annual exemption (increases with age)

Wisconsin: Up to $5,000 annually

Reciprocal Agreements

Some states have reciprocal agreements exempting residents of one state from income tax when stationed in another:

Example: North Dakota and Montana have reciprocity. If North Dakota resident stationed at Malmstrom AFB (Montana), pays North Dakota tax (which exempts military pay) instead of Montana tax.

Highest-Tax States to Avoid for Military Residency

California: 9.3-13.3%

E-7 with 16 years: $59,424 base pay → $5,517/year tax
O-4 with 14 years: $111,684 → $12,371/year tax

New York: 6.5-10.9%

Plus NYC resident tax adds 3-4% for city residents
E-6 with 10 years: $47,112 → $3,064/year state tax

New Jersey: 5.5-10.75%

O-3 with 8 years: $91,188 → $5,470/year tax

Oregon: 5-9.9%

Minnesota: 5.35-9.85%

Vermont: 3.35-8.75%

How to Establish Tax-Favorable Residency

Step 1: Choose Your Residency State Strategically

Ideal characteristics:

No state income tax
Military-friendly (many installations for future assignments)
Low vehicle registration fees and property taxes
State where you might eventually retire

Top Military Residency States:

Florida: No income tax, many installations, retiree-friendly
Texas: No income tax, huge military presence, strong economy
Nevada: No income tax, Las Vegas area has Nellis AFB/Creech AFB
Washington: No income tax, Joint Base Lewis-McChord, Navy/Coast Guard presence

Step 2: Establish Domicile Through Official Actions

To establish new state residency, take multiple official actions demonstrating intent:

Required Actions:

Update state of legal residence in DEERS/personnel system
Obtain driver’s license in new state
Register vehicle in new state
Register to vote in new state

Strongly Recommended:

File Declaration of Domicile (if state offers it)
Open bank account in new state
Update will/estate documents showing new state residence
Update beneficiary forms (SGLI, TSP) with new state address

Step 3: Use Family Member Address if Needed

You need a physical address in your claimed state of residency. Options:

Family member’s address (parents, siblings)
Property you own (even rental property managed by company)
Commercial mail forwarding service (some states accept, some don’t)

Important: Address must be real physical address, not PO Box.

Step 4: Maintain Residency Throughout Career

Once established, maintain residency by:

Renewing driver’s license in resident state
Keeping vehicle registration in resident state
Filing state tax returns in resident state (even if zero tax owed)
Not taking actions that suggest abandoning residency (like registering to vote elsewhere)

When to Change State Residency

Scenario 1: PCS to No-Tax State

You’re currently California resident (high tax), receiving PCS orders to Texas.

Action: Immediately upon arrival in Texas:

Update DEERS to Texas residency
Obtain Texas driver’s license
Register vehicle in Texas
Establish Texas domicile

Your California tax liability ends, Texas tax (zero) begins.

Scenario 2: Stationed in High-Tax State, Family in No-Tax State

You’re stationed in Virginia. Spouse and kids live in Florida (geo-bachelor assignment or family preference).

Action: Establish Florida residency using spouse’s Florida address. You pay zero Florida income tax even while stationed in Virginia.

Scenario 3: Early Career Residency Optimization

You enlisted from Pennsylvania (income tax state). After tech school, your first assignment is Nellis AFB, Nevada.

Action: Change residency to Nevada during first assignment. Save taxes for entire remaining career (potentially 15-25 years = $60,000-$150,000 in tax savings).

Special Considerations for Military Spouses

Military Spouses Residency Relief Act (MSRRA): Allows military spouse to claim same state of residence as service member, even when spouse works in different state.

Example:

Service member: Texas resident (no income tax)
Spouse: Works in Virginia earning $50,000/year
Without MSRRA: Spouse pays Virginia income tax (~$2,800/year)
With MSRRA: Spouse claims Texas residency, pays $0 state tax
Annual Savings: $2,800

Requirements for MSRRA:

Spouse must be in state solely to be with service member on military orders
Both service member and spouse claim same state of residence
Spouse provides documentation to employer (DD-2058, LES showing residency, etc.)

States That Try to Tax Military Despite SSCRA

Some states aggressively audit military members, claiming they established new residency by actions taken while stationed there:

Common Triggers:

Buying house in duty station state
Registering business in duty station state
Filing for in-state college tuition
Getting professional license in duty station state

Defense: Maintain clear documentation of legal residence elsewhere. Keep records of:

Driver’s license from claimed state
Voter registration from claimed state
Declaration of domicile
Tax returns filed in claimed state

Tax Situations Requiring Professional Help

Combat Zone Tax Exclusion (CZTE) Timing

Entering/leaving combat zones mid-year creates complex state tax situations, especially for states that don’t recognize CZTE.

Dual-State Situations

PCS mid-year from one state to another requires filing part-year returns in both states. Requires careful allocation of income.

Non-Military Income in Duty Station State

If you earn non-military income (rental property, business, part-time job) in state where you’re stationed, that income may be taxable even if military pay isn’t.

Example: Florida resident stationed in California. Military pay exempt from CA tax. Rental property income from CA property IS taxable by California.

Retirement Considerations

When you retire, your military pension is taxed by your state of residence at retirement. Choose carefully:

States NOT Taxing Military Retirement:

All nine no-income-tax states (Alaska, Florida, Nevada, NH, SD, Tennessee, Texas, Washington, Wyoming)
Alabama
Hawaii
Illinois
Kansas (starting 2023)
Mississippi
Pennsylvania

States Partially Exempting Military Retirement:

Arizona: $3,500 annual exemption
Georgia: $35,000-$65,000 exemption depending on age
Indiana: $6,250 exemption
Louisiana: $50,000 exemption
North Carolina: $4,000 exemption
Virginia: Up to $40,000 exemption

Planning Tip: If you maintain no-tax state residency throughout career, then retire to that state (or another no-tax state), you never pay state income tax on military compensation—active or retired.

Annual Tax Savings Across Career

E-5 Comparing California vs Texas Residency (20-Year Career):

Average annual California tax: $3,200
Average annual Texas tax: $0
20-year savings: $64,000

O-4 Comparing New York vs Florida Residency (20-Year Career):

Average annual New York tax: $6,500
Average annual Florida tax: $0
20-year savings: $130,000

Add Retirement Phase (30 Years):

O-4 retirement pay: $60,000/year
New York tax on retirement: ~$3,900/year
Florida tax on retirement: $0
30-year retirement savings: $117,000
Total career + retirement savings: $247,000

Action Plan: Optimize Your State Tax Situation

Step 1: Evaluate Current Residency

Check current state of legal residence in myPay/personnel records
Calculate annual state tax on military pay
Identify potential savings from changing residency

Step 2: Choose Optimal Residency State

Prioritize no-income-tax states
Consider where family lives (for address purposes)
Think about eventual retirement location

Step 3: Establish New Residency

Time change to coincide with PCS if possible
Complete all required documentation
Update DEERS, driver’s license, voter registration, vehicle registration
File declaration of domicile if state offers it

Step 4: Maintain Residency

File annual state tax return (even if zero tax)
Renew driver’s license in resident state
Keep vehicle registration in resident state
Don’t take actions suggesting new residency elsewhere

Step 5: Educate Spouse

Ensure spouse understands MSRRA benefits
Provide employer with proper documentation
File state taxes correctly for spouse’s income

The Bottom Line

State income tax on military pay is optional if you plan strategically. Establishing and maintaining residency in a no-tax state can save $60,000-$250,000 over a military career plus retirement—money that belongs in your pocket, not state coffers.

This isn’t tax evasion. It’s using military-specific tax protections Congress specifically created for service members who serve wherever ordered. Take advantage of these protections and keep more of your hard-earned military pay.

The Military Money Manual – Comprehensive guide to military tax strategy including state residency optimization, combat zone exclusions, and retirement tax planning.

The Military Guide to Financial Independence and Retirement – Long-term financial planning for military families including tax-efficient strategies for active duty and retirement.

State Income Tax and Military Pay: Save $3,000-$8,000 Annually