The United States has a multi-tiered income tax system under which taxes are imposed by federal, state and most local governments. Federal and state income taxes are determined by applying a tax rate to a taxable income. The federal and state income taxes differ with respect to the tax rates and how they are applied, types of income that is taxable, deductions and tax credits allowed.
In 2018, pursuant to the 2018 tax reform bill, a new system went into effect: seven tax seven brackets and marginal tax rates ranging from 10% to 37%. State income tax rates, on the other hand, exhibit greater variation. Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming have no income tax. New Hampshire and Tennessee tax only interest income and dividends. All other states have either flat or progressive income tax systems. For example, among states that impose a flat income tax are Colorado (4.63%), Illinois (3.75%) and Indiana (3.3%). California's progressive tax system has the highest marginal tax rate of 13.3% on income above $1 million.
While most state tax returns start with federal adjusted gross income (AGI), certain states require adjustments to AGI. For example, retirement income is fully taxable by federal tax authorities, while a number of states partially or fully exempt retirement income from taxes. Alabama does not tax pensions received from civil service and the government. Connecticut exempts 50% of military retirement pay.
The federal tax system allows taxpayers to use standard deductions or itemized deductions. While the majority of states also allow the same itemized deductions from the federal tax return, certain states mandate adjustments. The most common adjustment is the exclusion of the federal deduction for state and local income taxes.
There are also differences with respect to tax credits. For example, the state of New York allows a tax credit based on 20% of premiums paid for long-term care insurance, while federal laws disallow such tax credits.