State and federal income taxes share many similarities, but they serve different purposes and are administered by different levels of government. Let’s explore the definitions of each to help you better understand how state and federal taxes work for tax filers and where the differences lie.
What is the difference between state and federal taxes?
The biggest difference comes down to who collects the tax and where the money goes:
Federal income tax: The Internal Revenue Service (IRS) collects federal income tax from taxpayers to fund the U.S. federal government.
State income tax: Your state government collects state income tax (if applicable) solely to fund programs and services within your state.
What does federal income tax pay for?
The U.S. government collects federal income tax to fund federal programs and expenses. To name a few:
Infrastructure and public transportation
Social programs
Disaster relief
Education and public services
National defense and law enforcement
Note: Social Security and Medicare taxes are separate from federal income tax, though they’re often withheld as a payroll tax (taken from your paycheck) at the same time.
What does state income tax pay for?
Similarly, your state collects income tax funds to pay the state’s bills, including things like:
Public schools and universities
Road maintenance and transportation
State law enforcement and emergency services
Healthcare and social programs
So, while both taxes pay for a lot of the same things, state income tax is used at the state level, and federal income tax is used at the national level.
What is federal income tax?
The IRS collects federal income tax on taxpayers’ annual earnings. This includes individuals, corporations, and other legal entities.
If you’re an employee, your employer usually withholds federal income tax from your paycheck automatically. But if you’re self-employed, you’ll typically need to make quarterly estimated tax payments to cover both income tax and self-employment tax.
How federal tax rates work
Federal income tax uses a progressive tax system, meaning your income is divided into tax brackets, and each portion is taxed at a different individual income tax rate.
At the end of the year, you must file a federal tax return to ensure you’ve paid an accurate amount of taxes:
What is state income tax?
State income taxes are like federal income taxes, but handled by your state government. If your state has an income tax, you’ll generally have taxes withheld from your paycheck and will likely need to file a state income tax return after the end of the tax year.
Just like federal income tax, if you didn’t pay enough state income tax, you may owe taxes. But if you overpaid your state income taxes or reduced your state tax liability with state-specific tax deductions or credits, you may get a state tax refund.
Differences from federal taxes
Tax rates vary by state (some have flat rates; others use progressive tax systems).
Each state has its own tax laws, rules, and deductions.
You may need to file multiple state returns if you live and work in different states (unless your state has a tax reciprocity agreement with the other state, and you are able to claim an exemption for the neighboring state).
What are local taxes?
In addition to federal and state taxes, you may also pay a different type of tax: local taxes. Local taxes are levied by counties, cities, or school districts. Local governments rely on local taxes for a substantial portion of their funding.
The revenue from these taxes funds local public services like:
Public schools
Police and fire departments
Local roads and infrastructure
Even if you live in a state with no income tax, local taxes are collected in various ways, such as property taxes and sales taxes on goods and services. Tax rates vary by municipality.
FAQs
The bottom line
While federal, state, and local taxes may feel similar, they each serve different roles in funding the services you rely on every day. Understanding how they work (and which ones apply to you) can make tax season a lot less confusing.
But you don’t have to figure it all out on your own. TaxAct can help you easily file your federal and state returns, walk you through each step, and ensure your information flows seamlessly between your federal and state returns so you can file quickly and with confidence.
All TaxAct offers, products and services are subject to applicable terms and conditions.
This article is for informational purposes only and not legal or financial advice.
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