Posted by The TaxAdvocate Group, LLC

Income Tax and Federal Income Tax: What's the Difference?

Income Tax and Federal Income Tax: What's the Difference?

The United States has a federal system for all taxpayers, but state rules vary widely.

The United States has a multi-tiered tax system under which federal, state, and sometimes local governments impose taxes. Federal and state income taxes are alike in that they use a percentage rate to taxable income but can differ significantly from these rates and how they are applied—the type of taxable income, deductions, and authorized tax credits.


Federal Income taxes

The U.S. Internal Revenue Code, which specifies federal tax rules, underwent significant changes in 2018 with the TCJA Acts. There are now 7 marginal tax brackets at the federal level: 10%, 12%, 22%, 24%, 32%, 35% and 37%.

For fiscal 2020, the maximum rate of 37% starts at $ 518,401 of taxable income for singles and $ 622,051 of income for couples filing jointly. For fiscal 2021, the maximum rate of 37% starts at $ 523,601 for singles and $ 628,301 for couples filing jointly.


State Income tax

State income taxes can vary widely from state to state. Florida, Nevada, Alaska, South Dakota, Texas, Wyoming, Tennessee, and Washington do not collect income tax. New Hampshire only taxes dividends and interest, not income from salaries and wages, but is in the process of waiving this tax through a five-year phase-out, which is expected to end in January 2024. New Hampshire used to tax interest and dividends but was removed on January 1, 2021.

All other states have fixed or progressive income tax systems. A single tax system is one that applies a single tax to all income levels. Eight states will use this method in 2021: Pennsylvania (3.07%), Indiana (3.23%), Michigan (4.25%), Colorado (4.55%), Utah (4.95%), Kentucky (5%), Massachusetts (5%), and North Carolina (5, 25%).

However, most states that apply income tax use progressive tax systems, in which higher income levels are taxed at a higher rate, as is the case with the federal system income tax. Some states base their marginal tax contributions for this purpose on the federal tax code, but many states apply them. Some adjust their parentheses each year to keep up with inflation, as the federal government does, while others do not.

Kansas only has three tax brackets this year, while Hawaii has 12. California's progressive tax system has the highest maximum tax rate of 13.3%, which applies to singles with taxable income over $ 1 million and couples with more income at $ 1,181,484. North Dakota, at 2.9%, which applies to singles or couples with incomes over $ 433,200, has the lowest maximum marginal tax rate.

Some states tax pensions and Social Security income, while others do not.


Special considerations

In the federal tax system, taxpayers can claim a standard deduction or itemize their deductions. Standard deductions increased significantly in 2018 under the TCJA, making it more profitable for many taxpayers to simply accept the standard deduction. For fiscal 2020, the standard deduction was $ 12,400 for single and married taxpayers filing separately, $ 18,650 for heads of households, and $ 24,800 for couples filing jointly.

For the fiscal year 2021, the standard deduction has increased to $ 12,550 for single and married applicants filing separately, $ 18,800 for a head of households, and $ 25,100 for joint marriage filings.

States and the federal government differ in the types of income they charge and the deductions and credits they allow. For example, pensions and Social Security income are taxed in accordance with federal regulations, while several states exempt them from tax. Income U.S. Treasury bills, including bonds, are subject to federal tax.


Example of state income tax vs. federal income tax

Consider the example of a single taxpayer living in New Hampshire who reports taxable income of $75,000 per year, plus interest income of $ 3,000 on his/her federal tax return. New Hampshire, for instance, has a $2,400 tax exemption for interest and dividends, so tax is only paid on the remaining $600 ($ 3,000 - $ 2,400) in interest and dividends.

The taxpayer would then pay only $30 ($ 600*0.05) in state taxes, as New Hampshire would not tax earned income, but investment income, plus the amount of the exemption, to a rate of 5%. The individual's effective state tax rate on total income of $ 78,000 (tax debt divided by taxable income) would be 0.038%.

However, if the same person were to reside in Kentucky, all of their taxable income, whether earned or not, would be subject to that state's flat rate of 5.00%. In this case, your tax collection would be $ 3,900 ($ 78,000 * 0.05).

As for federal taxes, in 2021, under the progressive system, this taxpayer would pay $ 995 for the first $ 9,950 of his/her income, which is included in 10% brackets. They would pay 12% of their income from $ 9,950 to $ 40,526 ($ 3,669.12) and 22% of the amount over $ 40,526 ($ 7,584.28) to a total federal tax account of 12 $ 248.40. Its effective federal tax rate would be 16.3%.


Summary 

  • The federal government and most states have income taxes, but their rules and rates can vary widely.

  • Federal taxes are progressive, with higher rates at higher income levels.

  • Some states have progressive tax systems, while others impose a fixed tax rate on all income.


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