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Filing your taxes

The Difference Between Federal vs State Taxes

Jo Willetts, EA

Director, Tax Resources

Published on: February 18, 2021

State and federal income taxes vary greatly from each other. Read on to learn about the difference and how it impacts you.

Federal vs state tax: Why do we pay taxes?

You may have always wondered why we pay taxes to the government. And not just federal taxes, but state taxes too. We pay taxes because the federal, state, and local municipalities need revenue to provide the necessary infrastructure to support their citizens. The taxes pay for a variety of government services like maintaining roads, highways, and bridges to funding public libraries, parks, and education, among many other things.

The differences between state and federal taxes are federal income taxes are collected by the federal government to pay their bills and state taxes are collected by individual state governments to pay their specific state bills. Not every state has a state income tax; the seven states without an income tax are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming, while Tennessee and New Hampshire only tax unearned income.

State income tax

State income tax is levied by a state on a taxpayer’s income that was earned in or because they live in the state. These taxes are used to pay the state's bills and provide certain state programs. Taxpayers must file a state tax return for every tax-levying state where they earned income, but only the state they live in can tax all of their income.

Taxes vary by each state and not all of them follow the same tax system. Nine states have a flat-rate income tax system, which means that all income levels are taxed at the same rate. The nine states are Colorado, Illinois, Indiana, Kentucky, Massachusetts, Michigan, North Carolina, Pennsylvania, and Utah. The flat-state income tax rates vary and are not all the same for each of those nine states. The other 35 states and the District of Columbia have a progressive income tax system, which means that a taxpayer’s income is taxed in various brackets at different rates that increase as the taxpayer’s annual income increases. Usually, state income tax laws are more simplified compared to the federal tax code, with fewer tax brackets and generally lower tax rates. Tax brackets vary by each state and certain states even have tax laws that routinely adjust tax brackets and rates based on inflation.

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Federal income tax

Federal income tax is the tax imposed by the Internal Revenue Service (IRS) on the yearly earnings of taxpayers, corporations, trusts, and other legal entities. Federal income taxes are applied to all forms of income that make up a taxpayer’s taxable income, like wages or capital gains.

Federal income tax is broken down into tax brackets. Each bracket includes a “chunk” of income and is based on the filing status. Taxpayers' taxable income is then taxed based on their bracket. Since the U.S. has a progressive tax rate structure, you will always pay the lower tax rate on all “chunks” of income in the lower brackets than the final amount in the highest bracket for that taxpayer. All of these are added together to provide the taxpayer with their taxes before credits. The taxpayer can also use the tax rate equation for their filing status and their taxable income amount. The equation has the various rates below the highest one factored in.  

State income tax vs. federal income tax example

State income taxes are lower than federal income taxes. Mainly because the states also assess various types of property taxes, sales taxes, and even locality taxes in some states. While the federal income tax is the main source of federal income.

However, when you add the tax bites together you can see a large chunk of change going out to the taxing authorities. 

For example, if you take a single 40-year-old taxpayer in Pennsylvania with a taxable federal income of $65,000 and a $5,000 401(k) contribution making his or her Social Security, Medicare, and PA income $70,000, you can really see the effect.

  • Fed income tax $7,074
  • Social Security tax $4,340
  • Medicare tax $1,015
  • Pennsylvania tax $2,149

While this example makes the state taxes look substantially lower than the federal taxes, remember the state can and does collect taxes in many different ways.

Local tax

In some cases, individual municipalities may impose their own tax on local taxpayers. These taxes fund local public services ranging from education to garbage collection and sewer maintenance. Local taxes can come in many forms, from property taxes, payroll taxes, and sales taxes. Local taxes can differ from one municipality to the next.

About the Author

Jo Willetts, Director of Tax Resources at Jackson Hewitt, has more than 35 years of experience in the tax industry. As an Enrolled Agent, Jo has attained the highest level of certification for a tax professional. She began her career at Jackson Hewitt as a Tax Pro, working her way up to General Manager of a franchise store. In her current role, Jo provides expert knowledge company-wide to ensure that tax information distributed through all Jackson Hewitt channels is current and accurate.

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