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

In the United States, taxpayers operate within a dual system of taxation, contributing to both federal and state governments. The federal government imposes a uniform tax system across the country, while each state establishes its own tax laws and procedures. This means tax season involves filing at least two separate returns with different requirements and calculations. Federal taxes address national priorities, while state taxes are tailored to the needs of local populations.

Federal Tax System Overview

The U.S. government levies federal taxes, which are administered by the Internal Revenue Service (IRS). Federal tax revenue is the primary source of funding for national programs like defense, Social Security, and Medicare.

Federal taxes also support infrastructure projects like the interstate highway system, government agencies, scientific research, and federal law enforcement. The federal tax system is uniform, meaning tax rates and rules are the same for all citizens regardless of their state.

The most prominent federal tax is the individual income tax, which is structured progressively. As an individual’s income increases, they move into higher tax brackets and pay a larger percentage of their income in taxes. For the 2025 tax year, these brackets range from 10% to 37%.

Another source of federal revenue is the corporate income tax, levied on corporate profits at a flat 21% rate. Businesses are also subject to payroll taxes under the Federal Insurance Contributions Act (FICA). FICA taxes fund Social Security and Medicare, with the Social Security tax levied on wages up to $176,100 for 2025 and the Medicare tax applying to all earned income.

Federal excise taxes are imposed on the sale of specific goods like gasoline, tobacco, and alcohol. The revenue from these taxes is often earmarked for related purposes. For example, federal gasoline taxes help fund the Highway Trust Fund for road and transit projects.

State Tax System Overview

State tax systems are diverse, as each of the 50 states has its own tax agency and laws. This autonomy results in a wide spectrum of tax structures, rates, and rules. The revenue funds state-level services and supports local governments.

Services funded by state taxes include public education, from K-12 schools to state universities. State tax revenue also funds transportation, including the maintenance of state highways and roads, and public safety, such as state police and correctional facilities.

The variation among states is apparent in their approach to income tax. Most states use a progressive income tax system similar to the federal model, where tax rates increase with income. A smaller number of states have a flat tax system, where all income is taxed at a single rate.

Some states do not levy a broad-based individual income tax. To compensate, these states often rely more heavily on other forms of taxation. The nine states with no individual income tax are:

• Alaska
• Florida
• Nevada
• New Hampshire
• South Dakota
• Tennessee
• Texas
• Washington
• Wyoming

Beyond income taxes, states use other methods to generate revenue, like sales tax on goods and services. Property tax is another major revenue source, authorized at the state level but primarily funding local governments and school districts. Property taxes are based on the assessed value of real estate.

Key Differences in Taxable Income

Calculating taxable income is a central point of divergence between federal and state systems. The process for determining state taxable income often begins with the federal Adjusted Gross Income (AGI). AGI is a person’s gross income minus specific “above-the-line” deductions, like contributions to traditional IRAs or student loan interest.

From the federal AGI, states apply their own rules, requiring additions and subtractions to determine state taxable income. These adjustments reflect each state’s policy choices. For example, interest earned on U.S. Treasury bonds is taxable at the federal level but is almost universally exempt from state taxation.

Conversely, states may require additions for income not taxed by the federal government. For instance, interest from municipal bonds issued by another state is exempt from federal tax. However, a state will require its residents to add this out-of-state bond interest to their income for state tax purposes.

Differences also extend to deductions. The federal system offers a standard deduction if taxpayers choose not to itemize. For 2025, the federal standard deduction is $15,000 for single filers, $30,000 for married couples filing jointly, and $22,500 for heads of household. Many states also offer a standard deduction, but the amount can be substantially different from the federal one.

Tax credits, which provide a dollar-for-dollar reduction of tax liability, also vary between federal and state systems. Both governments use credits to incentivize certain behaviors. However, the specific credits offered are often unique to each jurisdiction.

The Interaction Between Federal and State Taxes

The separate federal and state tax systems have direct interactions that affect a taxpayer’s liability. A primary interaction is the State and Local Tax (SALT) deduction. This federal provision allows taxpayers who itemize to subtract certain taxes paid to state and local governments from their federally taxable income, including income, sales, and property taxes.

This deduction reduces the federal income tax burden for people in states with higher tax rates. However, the SALT deduction is currently capped at $10,000 per household per year. This cap restricts the amount of state taxes that can be deducted on a federal return. The cap is scheduled to expire after 2025 unless Congress extends it.

Another area of interaction is “conformity,” where states align their tax codes with the federal Internal Revenue Code (IRC) to simplify filing. When federal tax laws change, these changes can automatically apply at the state level. Some states use “static conformity” (adopting the IRC as of a specific date), while others use “rolling conformity” (adopting federal changes as they occur).

Conformity has direct consequences for state tax revenues and individual tax bills. If the federal government introduces a new deduction, conforming states may see their tax bases change. This requires state legislatures to monitor federal tax policy and decide whether to “decouple” from provisions that do not align with state objectives.