Is Federal or State Tax Return Bigger? Factors to Consider

Taxpayers often wonder whether their federal or state tax return will be larger, a question that holds importance for financial planning. Determining which return might be bigger depends on several factors that influence both federal and state taxes, including rate differences, withholding practices, deductions, credits, filing status, and additional income sources.

Rate Differences

The disparity in tax rates between federal and state levels significantly impacts the size of tax returns. Federal income tax rates are progressive, ranging from 10% to 37% as of 2024, applying uniformly across the United States based on income brackets. State tax rates, however, vary widely. Some states, like Florida and Texas, impose no income tax, while others, such as California and New York, have rates exceeding 10% for high earners. These variations can create substantial differences in tax owed and the resulting return.

The calculation of taxable income also differs between federal and state systems. While the federal government allows for standard or itemized deductions, states may have unique deductions and credits. For example, some states offer deductions for contributions to state-specific college savings plans, which are not recognized federally. These differences further influence the size of federal and state returns.

Withholding Factors

The amount withheld from paychecks throughout the year is a key factor in determining the size of a tax return. Employers calculate federal withholding based on employees’ W-4 forms, which specify filing status and optional additional withholding. Higher withholding can result in larger refunds, whereas lower withholding may lead to smaller refunds or even a tax liability.

State withholding practices often differ from federal ones, adding another layer of complexity. Each state has its own guidelines for withholding calculations, which may not align with federal standards. For instance, some states require additional forms or provide unique withholding allowances. These differences can result in varying amounts withheld for state versus federal taxes, ultimately affecting the size of each return.

Deductions and Credits

Deductions and credits play a critical role in shaping the size of tax returns. At both the federal and state levels, deductions reduce taxable income, while credits directly lower the amount of tax owed. For example, federal deductions like the Educator Expense Deduction allow eligible taxpayers to deduct up to $300 for classroom-related expenses.

Tax credits can have an even greater impact. The federal Child Tax Credit offers up to $2,000 per qualifying child, with up to $1,500 refundable. States may also provide credits, such as the California Earned Income Tax Credit, which benefits low-to-moderate-income taxpayers. Understanding the interplay between federal and state deductions and credits is crucial for optimizing tax outcomes.

Recent tax reforms, such as the Tax Cuts and Jobs Act, continue to influence deductions and credits. For instance, the $10,000 cap on state and local tax deductions remains relevant in 2024, directly affecting taxpayers in high-tax states. Staying informed on such changes is critical to maximizing benefits and avoiding missed opportunities.

Filing Status

Selecting the correct filing status is a foundational step in tax preparation that significantly affects tax liability and refunds. The Internal Revenue Code provides five filing statuses: Single, Married Filing Jointly, Married Filing Separately, Head of Household, and Qualifying Widow(er) with Dependent Child. Each status comes with unique tax brackets and standard deductions. For instance, in 2024, Married Filing Jointly offers a standard deduction of $27,700, while Single filers receive $13,850.

Filing status also determines eligibility for certain credits and deductions. For example, taxpayers filing as Head of Household benefit from a larger standard deduction and more favorable tax brackets compared to Single filers. This status is available to unmarried taxpayers who pay more than half the cost of maintaining a home for a qualifying dependent, such as a child or parent.

Additional Income Sources

Additional income sources, such as investments, rental properties, freelance work, or side businesses, can significantly influence federal and state tax returns. These income streams are often taxed differently than regular wages, affecting overall liabilities.

Investment income, for instance, is taxed at lower rates federally for qualified dividends and long-term capital gains—typically 0%, 15%, or 20%, depending on income. Many states, however, tax capital gains as ordinary income, which can result in higher state tax liabilities for investors. Exceptions exist, such as New Hampshire and Tennessee, which do not tax dividends and interest.

Rental income and self-employment earnings bring further complexities. Self-employed individuals must pay federal self-employment taxes, which include Social Security and Medicare contributions, while states may not impose equivalent taxes. Additionally, deductions specific to self-employment, like the home office deduction, vary between federal and state rules, impacting taxable income and refund potential.