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

State Income Tax vs. Federal Income Tax: An Overview

The United States 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, but they differ considerably with respect to those rates and how they’re applied, as well as to the type of income that is taxable and the deductions and tax credits that are allowed.

State Income Tax

State income taxes can vary considerably from one state to another. Most states have either flat or progressive income tax systems. A flat tax system applies a single rate to all levels of income. 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, higher levels of income are taxed at a greater 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.

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, at 2.9%, which applies to singles or married couples with incomes over $440,600, has the lowest top marginal tax rate.

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.

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.

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 simply to take the standard deduction.

The standard deduction for the 2021 and 2022 tax years are as follows:

• $12,550 and $12,950 for single taxpayers and those married individuals filing separately
• $18,800 and $19,400 for heads of households
• $25,100 and $25,900 for married couples filing jointly

As mentioned above, states and the federal government differ in terms of the types of income that are taxed and the deductions and credits that they allow. For instance, pension and Social Security income are taxable under federal rules, while a number of states exempt these sources of income from taxation. Other income exemptions include 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. New Hampshire has a $2,400 tax exemption for the interest and dividends tax, so tax is only due on the remaining $600 ($3,000 − $2,400) of interest and dividends income.

This means that the taxpayer would pay just $30 ($600 × 0.05) in state taxes because New Hampshire taxes investment income rather than earned income over the exemption amount at the rate of 5%. This individual’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, in 2021, under the progressive system, this taxpayer would pay $995 on the first $9,950 of their income (excluding interest) which 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%.