What’s the Difference Between State vs. Federal Taxes?

We get it: Taxes can be overwhelming, stressful, and just plain confusing. When it comes to tax liabilities, how do you know who your money is going to and what it’s being used for? The answer can be a bit complex, because state taxes and federal taxes serve different purposes. Understanding the key differences is important for tax planning and management. 

For those who are constantly on the move or do business in more than one state, the question of state taxes can be even more complicated. Let’s break down the key differences between state vs. federal taxes, explain how they impact taxpayers, and highlight what you need to know when filing.

What are Federal Taxes?

Federal taxes are levied by the United States government to fund national programs and services. There are several categories these taxes can fall into:

• Income Tax: This type of tax applies to wages, salaries, and other income sources. The amount owed is a percentage of your income based on layers called tax brackets—the higher your income, the higher the tax rate. 
• Payroll Taxes: As the name indicates, payroll taxes are generally withheld from your paycheck. These include Medicare and Social Security taxes.
• Corporate Income Tax: Businesses classified as corporations pay income taxes on their profits. This is one of the top revenue sources for the federal government, 
• Estate and Gift Taxes: Significant transfers of money, property, or assets made by living persons or passed on after death are taxed if they exceed certain amounts.

Federal taxes are used for a number of government programs and initiatives, including but not limited to national defense, infrastructure, healthcare, and federal debt repayment.

What are State Taxes?

State taxes, as their name implies, are levied by individual state governments to fund local services and infrastructure specific to the state. The important thing to remember when it comes to state taxes vs. federal taxes is that protocols vary from state to state—one state might levy a tax on something that a neighboring state does not.

• Income Tax: State income tax differs from federal income tax in that not all states use a bracketed method that charges a higher percentage for a higher income. Some states charge flat rates, some charge progressive rates, and some states—including Alaska, Florida, and Texas—have no income tax at all.
• Sales Tax: When you purchase goods or services, a consumption tax that adds a percentage of the purchase price to the total is exacted. This is true of most retail goods, though what qualifies for sales tax and at what rate varies by state.
• Property Tax: Property like real estate and, in certain states, vehicles, is taxed by local governments based on the value of said property.
• Excise Taxes: Some states levy taxes on specific, targeted items, like gasoline, alcohol, or tobacco.
• Other State-Specific Taxes: Luxury taxes, inheritance taxes, or state estate taxes.

State taxes are used for services like public education, transportation, law enforcement, healthcare, and other state-specific programs and initiatives.

Key Differences Between State vs. Federal Taxes

When comparing state vs. federal taxes, there are a number of distinctions that can be difficult to keep track of. Let’s go over the most important differences:

1. Tax Rates and Structures

Federal income taxes utilize a progressive rate structure, which means that the higher your income, the higher your tax rate. This is where those “tax brackets” come into play, determining the percentage owed by the income made. State income taxes, on the other hand, vary; a state might charge a flat fee, utilize a progressive rate structure, or charge no income tax at all. The nine states that levy no income tax as of 2024 are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.

2. Tax Forms and Filing Requirements

Another key difference in state vs. federal taxes comes into play with filing requirements. Federal taxes are filed via IRS Form 1040. Each state, however, has its own specific forms—for example, California’s Form 540 or New York’s IT-201. Some states even have additional requirements for deductions and credits.

3. Use of Tax Revenue

Another distinction is how the government uses the taxes levied. Federal revenue goes into national initiatives, things like Social Security and national defense that are not specific to regions or states. State revenue supports needs that function on a more local basis: schools, highways, public welfare, etc. 

4. Deductions and Credits

Tax credits essentially reduce the taxes you owe, and deductions reduce the amount of taxable income you have. Federal taxes have both standard deductions and itemized deductions—things like mortgage interest or contributions to charity. On a state level, credits and deductions vary. Some states might offer state-specific credits for college savings or renting. 

5. Tax Filing Deadlines

Another very important distinction between state vs. federal taxes is the filing deadline. Federal taxes are generally due on April 15 every year. Some states might align with this federal deadline, and others may not; make sure you know when your state tax deadline is.

6. Residency Rules and Taxation

Federal taxes are levied based on national residency and citizenship. If you are a lawful, permanent resident of the United States at any time during the year, including via green card, or if you meet the substantial presence test, you will be taxed for residency. Once again, these rules vary from state to state with considerations for part-year residents, non-residents, and residents who make income across multiple states.  

Be Prepared for Your Tax Situation

As you can see, there are a lot of considerations that go into those annual state and federal taxes. Here at Credit Central, we understand that keeping track of all these rules and percentages can be tricky. We’re here to help! Contact us today to understand your tax situation and be prepared for filing.