State Income Tax vs. Federal Income Tax: What's the Difference?

The U.S. has one system for all taxpayers, but state rules vary

State Income Tax vs. Federal Income Tax: An Overview

The U.S. has a multitiered income tax system under which taxes are imposed by federal, state, and sometimes local governments. Federal and state income taxes are similar in that they apply a percentage rate to taxable incomes. However, they differ considerably regarding those rates and how they're applied—and by the type of income that is taxable and the deductions and tax credits allowed.

Key Takeaways

  • The federal government and most states have income taxes.
  • The rules and rates vary between individual states and the federal system.
  • Federal taxes are progressive, with higher tax rates on higher income levels.
  • Some states have a progressive tax system, while others impose a flat tax rate on all income.
  • The Tax Cuts and Jobs Act of 2018 made changes to the federal tax system, including an increase to the standard deduction.

State Income Tax

State income taxes can vary considerably from one state to another. Most states have either a flat or progressive income tax system. A flat tax system (also called a single-rate structure) applies a single tax rate to all income levels. Nine states use this method as of 2021, including Colorado (4.55%), Illinois (4.95%), Indiana (3.23%), Kentucky (5%), Massachusetts (5%), Michigan (4.25%), North Carolina (5.25%), Pennsylvania (3.07%), and Utah (4.95%).

In states that use progressive tax systems, greater income levels are taxed at a higher percentage rate. This is the same system used in the federal income tax system. Some states base their marginal tax brackets for this purpose on the federal tax code, but many states implement their own. Some adjust their brackets annually to keep pace with inflation, as the federal government does, while others do not.

Here's a look at the top state marginal individual income tax rates for 2021:

Top State Marginal Individual Income Tax Rates for 2021

Source: Tax Foundation

Hawaii has 12 tax brackets, while Kansas has only three. California's progressive tax system has the highest top tax rate of 13.3%, which applies to singles with taxable incomes over $1 million and married couples with incomes over $1,198,024. North Dakota has the lowest top marginal tax rate, with a 2.9% rate that applies to singles and married couples with incomes over $440,600.

Some states have little to no income tax at all. Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming don't tax residents on their income. New Hampshire only taxes income from interest and dividends—not earned income from salary and wages. The state is phasing this out gradually and plans to repeal this fully by January 2026. Tennessee used to tax interest income and dividends, but it completed a phase-out as of Jan. 1, 2021.

Income taxes are a significant source of revenue for individual states and the federal government, accounting for nearly 50% of federal revenue.

Federal Income Tax

The U.S. Internal Revenue Code (IRC), which spells out the federal income tax rules, underwent some significant changes in 2018 with the passage of the Tax Cuts and Jobs Act (TCJA). There are now seven marginal tax brackets at the federal level: 10%, 12%, 22%, 24%, 32%, 35%, and 37%.

For the 2021 tax year, the top rate of 37% kicks in at $523,600 in taxable income for singles and $628,300 in income for married couples filing jointly. For the 2022 tax year, the top rate of 37% applies at $539,900 for singles and $647,850 for married couples filing jointly.

Here's a breakdown of the tax brackets and rates for 2021:

2021 Federal Tax Brackets and Rates
 2021 Tax Rate Single Married Filing Jointly Heads of Households
10%  Up to $9,950  Up to $19,900  Up to $14,200
12%   $9,951 to $40,525  $19,901 to $81,050  $14,201 to $54,200
22%   $40,526 to $86,375  $81,051 to $172,750  $54,201 to $86,350
24%   $86,376 to $164,925  $172,751 to $329,850  $86,351 to $164,900
32%   $164,926 to $209,425  $329,851 to $418,850 $164,901 to $209,400 
35%   $209,426 to $523,600  $418,851 to $628,300  $209,401 to $523,600
37%   $523,601 or more  $628,301 or more  $523,601 or more

And here are the tax brackets and rates for 2022:

2022 Federal Tax Brackets and Rates
 2022 Tax Rate Single Married Filing Jointly Heads of Households
10% $0 to $10,275 $0 to $20,550  $0 to $14,650
12%   $10,275 to $41,775  $20,550 to $83,550 $14,650 to $55,900
22%  $41,775 to $89,075 $83,550 to $178,150 $55,900 to $89,050
24%  $89,075 to $170,050 $178,150 to $340,100 $89,050 to $170,050
32%  $170,050 to $215,950 $340,100 to $431,900 $170,050 to $215,950
35%   $215,950 to $539,900  $431,900 to $647,850  $215,950 to $539,900
37%  $539,900 or more  $647,850 or more  $539,900 or more

Special Considerations

Taxpayers can claim either a standard deduction or itemize their deductions under the federal tax system. Standard deductions increased considerably in 2018 under the TCJA, making it more advantageous for many taxpayers to take the standard deduction.

Here's a look at the standard deductions for the 2021 and 2022 tax years:

Standard Deduction Amounts for 2021 and 2022
 Filing Status 2021 Standard Deduction 2022 Standard Deduction
 Single  $12,550 $12,950
Married Filing Separately   $12,550 $12,950
Heads of Household   $18,800 $19,400
Married Filing Jointly   $25,100 $25,900
Surviving Spouses   $25,100 $25,900

As mentioned above, states and the federal government differ in terms of the types of income that are taxed and the deductions and credits they allow. For instance, pension and Social Security income are taxable under federal rules, while some states exempt these sources of income from taxation. Other income exemptions include earnings from U.S. Treasury securities, such as savings bonds. These sources of income are exempt from state tax but are subject to federal taxes.

State Income Tax vs. Federal Income Tax Example

Consider a single taxpayer who lives in New Hampshire and reports taxable earned income of $75,000 a year plus interest income of $3,000 on their federal tax return.

We'll start with the state income taxes. New Hampshire has a $2,400 tax exemption for the interest and dividends tax, so tax is due only on the remaining $600 ($3,000 − $2,400) of interest and dividends income.

This means the taxpayer would pay just $30 ($600 × 0.05) in state taxes because New Hampshire taxes interest and dividend income only—at the rate of 5%. The taxpayer's effective state tax rate on their total income of $78,000 (tax obligation, $30, divided by taxable income, $78,000) would be 0.038%.

If this same person lived in Utah, all of their taxable income—both earned and unearned—would be subject to that state's 4.95% flat tax rate. In that case, their tax bill would be $3,861 ($78,000 × 0.0495).

In terms of federal taxes, under the progressive system, this taxpayer would pay $995 on the first $9,950 of their income (excluding interest) that falls into the 10% tax bracket. They would pay 12% on their income from $9,950 to $40,526 ($3,669.12), and 22% on the amount greater than $40,526 ($7,584.28) for a total federal tax bill of $12,248.40. Their effective federal tax rate would be 16.3%.

What Is the Difference Between Federal and State Income Taxes?

Federal income taxes are collected by the federal government, while state income taxes are collected by the individual state(s) where a taxpayer lives and earns income. There are seven federal tax brackets, ranging from 10% to 37%, depending on your income and filing status. At the state level, some states use a flat-rate tax, while others impose a progressive system or have no state income tax at all.

Do Federal Income Taxes Differ by State?

Federal income tax rates are based on your income and filing status—not by where you live. Therefore, the same federal tax rates apply to everyone, no matter which state they live in. However, state taxes vary, so a taxpayer's total tax liability will differ depending on where they live and earn income.

Which State Have No State Income Tax?

Seven states—Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming—have no state income taxes. New Hampshire doesn't tax earned wages, but it does tax interest and dividend income. However, New Hampshire will begin phasing out these taxes at the end of 2023, and by 2027, personal income tax in the state will be tax-free.

Article Sources

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