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 2015, the IRS established federal tax rates with seven brackets and marginal tax rates ranging from 0 to 39.6%. 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 and dividends. All other states have either flat or progressive income taxes. For example, among states that impose a flat income tax are Colorado (4.63%), Illinois (3.75%) and Indiana (3.3%). Unlike other states, California has a progressive tax system with the highest margin 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.

There are differences with respect to taxing bond interest. For example, interest received on U.S. savings bonds is subject to federal taxes, while states exempt interest on U.S. savings bonds.

The federal tax system allows taxpayers to use standard 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.

  1. How can I lower my effective tax rate without lowering my income?

    Discover how to reduce your effective tax rate without losing income by maximizing adjustments and deductions, earning tax-free ... Read Answer >>
  2. How does the marginal tax rate system work?

    The marginal tax rate is the rate of tax that income earners incur on each additional dollar of income. Read Answer >>
  3. What are the differences between regressive, proportional, and progressive taxes?

    Learn about the three basic types of tax systems, all of which are used in the U.S., and how they affect different income ... Read Answer >>
  4. Who first came up with the idea of a progressive tax?

    Learn how the progressive income tax system developed in the United States and became the federal government's primary revenue ... Read Answer >>
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