Income tax is one of the key mechanisms through which governments finance a lot of their activities in infrastructure, social services, defense, and many others. In the United States of America, both the federal government and the state governments impose income taxes on persons and organizations as a means of increasing revenue. This paper explains the complexities of federal and state income taxes, their goals, and main differences in understanding how they work and affect the taxpayer.
Differentiation State Income Tax vs. Federal Income Tax in 2024.
Table of Contents
What is Income Tax?
Income tax is normally the tax levied by a government on individuals and businesses based on income. Such income emanates from wages, salaries, bonuses, investments, and many more. This revenue collected is used to fund such public services as healthcare, education, national defense, and public welfare. In the United States, income tax is collected primarily at two levels:
Federal Level – Managed through Internal Revenue Service – IRS
State Level – Administered through the various state revenue departments
Both federal and state income taxes are based upon a progressive tax system, which increases the tax rates as the level of the taxpayer’s income increases.
Federal Income Tax
Federal income tax is the largest source of revenue for the United States federal government. It is collected by the Internal Revenue Service and is levied on the taxable income of individuals, corporations, estates, and trusts. To begin, federal income tax operates in the following way:
Progressive Tax Rates
Federal income tax is progressive, meaning it utilizes the tax brackets that are established through the IRS. Federal income tax brackets for 2023 range from a minimum of 10% up to 37%, where the highest rates are levied on the highest-income earners. The more the taxpayer’s income increases, the higher it goes into tax brackets, which raises their effective rate of tax.
Taxable Income Calculation
It is calculated as gross income minus allowable deductions and exemptions. The IRS allows the standard deduction or itemized deductions to lower taxable income. Examples of deductions include mortgage interest, charitable contributions, and medical expenses. for more Information: https://www.nerdwallet.com/article/taxes/state-income-tax-rates
Tax Credits and Exemptions
Tax credits – the most common are the Earned Income Tax Credit, child tax credit, and education credits- are a direct reduction of the tax bill. Credits reduce the dollar-for-dollar bill of tax, unlike deductions that simply reduce taxable income. Exemptions do lower taxable income as well, but personal exemptions were eliminated by the 2018 Tax Cuts and Jobs Act.
Withholding and Quarterly Payments
The taxes withheld from employee wages are paid to the IRS by employers. The self-employed and some businesses must make quarterly estimated tax payments if their estimated annual income will owe taxes; otherwise, they may be subject to penalties for underpayment of estimated taxes.
Tax Filing and Deadlines
Federal income taxes are normally due on or before April 15 of each year. There are extensions, though, or if the areas are considered disaster zones and/or military service, special deadline relief may apply.
State Income Tax
State income tax is very heterogenous across the United States. Every state is free to formulate its own policies regarding income tax, and each state does not necessarily charge an income tax. Here is a summary of some considerations about state income tax:
Variation in Tax Rates
State income tax rates are all over the map. For example, states like California and New York are considered progressive states and have top income tax rates as high as 13.3% and 10.9%, respectively. Other states, such as New Hampshire and Tennessee, only tax dividend and interest income.
States With No Income Tax
Nine states do not currently impose an income tax on earned income: Alaska, Florida, Nevada, South Dakota, Texas, Washington, Wyoming, New Hampshire does not tax earned income but does tax dividends and interest income and Tennessee which is phasing out the tax on interest and dividend income.
Deductions and Credits
While federal government provides standardized deductions, states have different types of deductions and credits. Many states offer credits comparable to federal government credits like child tax credits or credits granted to senior citizens. Other states provide tax credits that are peculiar to them to assist local initiatives or industries.
Local Income Taxes
Apart from state income taxes, some cities and counties also impose local income taxes. For example, New York City, along with a few counties in Ohio, charges local income taxes in addition to state income taxes.
Agreements on Reciprocity
Reciprocity agreements between states mean that residents can work across state lines without filing an income tax return in both states. For instance, if you are a resident of Illinois and work in Iowa, under their reciprocity agreement, you will not have to file a state return in Iowa.
Key Differences Between Federal and State Income Taxes
While federal and state income taxes share similar structures, there are some key differences between the two:
Tax Brackets and Rates
Federal tax brackets are uniform nationally, while state income tax brackets and rates are all over the map. The million-dollar earners may be more heavily taxed in one state compared with another.
Deductions and Credits
The federal government allows for certain deductions and credits, but states often opt to also allow those or not at all. This can make a big difference in the total amount of tax owed by taxpayers and whether they even have to file a tax return.
Tax Administration and Filing Requirements
Federal income taxes are collected and administered by the Internal Revenue Service. The state tax is usually collected and processed by a state’s revenue department. Still, many states require separate tax returns, although some states like Maine allow combined federal and state returns for convenience.
Complications and Complexities of Income Tax
Federal and state income taxes can sometimes be a challenge, especially if one’s financial situation is a bit complicated or a business operates in multiple states. A precis of some common complications encountered by taxpayers is presented below.
State Rules on Residency
Another important aspect of residency is for the determination of tax liability. Residency can be defined differently in various states depending either on the length of time a person spends within the state boundaries or on the person’s domicile status. Consequently, all those who live or work in more than one state are burdened with added filing requirements or possible additional tax liabilities.
Double Taxation
Because of this, individuals who live in one state and work in another may experience double taxation. Some states fix the pain caused by this situation with a credit for taxes paid to other states. The reciprocity agreements discussed above help to soften the double taxation blow also.
Source of Income Classification
Income may be derived from capital gains, interest, dividends, and rental income. Each of these usually falls into a different tax rate bracket. Sometimes state tax laws further complicate things by taxing certain income sources that the federal government does not tax, or vice versa.
Changing Tax Laws
Income tax laws change frequently. For instance, the TCJA enacted significant changes in the federal tax code including its tax brackets, amount of its standard deduction, and elimination of personal exemptions. States also tend to change their tax laws periodically and often as part of a response to the federal changes.
Importance of Income Tax to the U.S. Economy
The income tax is a source of high revenue for the federal and state governments. At the federal level, revenue collected from income tax finances national priorities such as military expense, health, social security, infrastructure among other areas. Revenue collected from state income tax finances state priorities that include education, road maintenance, healthcare, law enforcement amongst other services.
Social programs financing
Federal income tax revenue pays for many social programs, including Medicare, Medicaid, and Social Security. State income taxes usually pay for state healthcare programs, public safety, and welfare.
Promoting Economic Stability
Income tax stabilizes the economy by redistributing wealth and providing the government with capital with which to respond to economic fluctuations. During economic downturns, revenue accumulated from taxes can be allocated to stimulus plans, unemployment benefits, and other types of aid.
Wealth Redistribution
This is due to the progressive nature of income tax, which allows for a fair manner of redistributing wealth in that higher earners contribute to services required by society in general, from public education through infrastructure and healthcare.
Conclusion
Federal and state income taxes form the basis of the United States by providing vital funds necessary for the running of the government and all public services. Knowing the differences and shades between these two levels of tax will enable individuals and businesses to make proper financial decisions. Adding federal income tax uniformity across the nation with different states’ income taxes creates an added layer of complexity based on where a citizen or company resides. In this respect, taxpayers need to be knowledgeable about both their federal and state tax requirements to remain in compliance with all laws and regulations to minimize their taxes owed.
The income tax has undoubtedly played its role in the ever-evolving face of taxation toward economic and social causes. Federal income taxes, working in tandem with state income taxes, balance revenue creation and equity considerations in a strong combination to undergird economic stability, infrastructure development, and public welfare in the United States.
