Two Different Masters: The IRS and the State

When tax season rolls around, most Americans focus entirely on the IRS. But the IRS only collects Federal Income Tax. Depending on where you live, you likely also owe State Income Tax to your state's Department of Revenue.

These two tax systems run parallel to each other, but they have completely different rules, tax brackets, and deduction allowances. Understanding the difference is crucial for effective tax planning.

Federal Income Tax: The Big One

Federal income tax applies to almost every individual living and working in the United States, as well as US citizens living abroad. The federal tax system is "progressive," meaning the more money you make, the higher the percentage you pay on your top earnings. Federal taxes fund national defense, federal programs like Medicare and Social Security, and national infrastructure.

State Income Tax: Where You Live Matters

State income taxes are collected by your specific state government to fund local roads, public schools, and state-level services. Unlike federal taxes, state tax systems vary wildly across the country.

  • Progressive Tax States: States like California and New York have progressive tax brackets similar to the federal system, with extremely high rates for top earners.
  • Flat Tax States: States like Pennsylvania and Illinois charge a single flat percentage rate to everyone, regardless of income level.
  • No Income Tax States: Nine states do not charge any state income tax on wages: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.

The Complexity of Moving (Part-Year Residency)

If you move from one state to another during the year, tax season becomes much more complicated. You will likely have to file a Part-Year Resident return in both your old state and your new state. You will split your income based on exactly when you moved and where the income was earned.

Similarly, if you live in one state but commute across the border to work in another (like living in New Jersey but working in New York), you may have to file a Non-Resident return in your work state and a Resident return in your home state. Fortunately, most states offer a tax credit to ensure you aren't double-taxed on the same income.

State Conformity: Does Your State Follow the IRS?

When Congress passes new federal tax laws, states must decide whether to "conform" to those rules. For example, the IRS allows a certain amount for the Standard Deduction. Your state might adopt that same number, or it might set its own, much lower standard deduction. Similarly, some states do not allow deductions for contributions to Health Savings Accounts (HSAs) or 529 College Savings Plans, even though the federal government does.

Conclusion

Never assume that your state tax return is just a carbon copy of your federal return. Because every state has its own quirky rules, it is highly recommended to use capable tax software or hire a local tax professional to ensure you are maximizing both your state and federal tax savings.