Federal vs. State Tax: What's the Difference?

Tax season is one of the most confusing times of the year, and a big part of that confusion comes from the fact that you aren't just paying one "government." You are paying two, completely separate ones: the Federal government and your State government.

Each one has its own rules, its own forms, and its own "tax brackets."

The simplest way to think about it is like this:

• Federal Tax: This is your "national" tax. Everyone in the United States, from a banker in New York to a farmer in Nebraska, pays this tax. It funds the entire country.
• State Tax: This is your "local" tax. It's paid only to the government of the state you live in. It funds your specific state.

Understanding how these two systems work—and how they don't work together—is key to understanding your paycheck and your total tax bill.

Federal Tax Brackets (The Big One)

The federal income tax is the U.S. government's primary source of revenue. It's run by the Internal Revenue Service (IRS).

What It Funds:

This is the money that pays for all the big, national-level programs:

• The U.S. Military (Army, Navy, Air Force)
• Social Security and Medicare
• National infrastructure (like the interstate highway system)
• Federal law enforcement (like the FBI)
• National Parks, scientific research (NASA), and all other national agencies.

How Federal Tax Brackets Work:

The United States uses a progressive tax system. This is a very important concept. It does not mean that if you're in the "22% bracket," you pay 22% on all of your money. That is the single biggest myth in taxes.

A progressive system means you pay different rates on different portions of your income. It's like filling up a series of buckets.

Let's look at the 2025 Federal Tax Brackets for a Single Filer:

How to Actually Read This (The Bucket Analogy):

Let's pretend your total taxable income is $50,000.

You are not in the 22% bracket. You are in all of the first three brackets.

1. The 10% Bucket: Your first $11,600 of income is taxed at 10%.
   • ($11,600 x 0.10) = **$1,160**
2. The 12% Bucket: Your next chunk of income (from $11,601 up to $47,150) is taxed at 12%.
   • ($47,150 - $11,600) = $35,550
   • ($35,550 x 0.12) = **$4,266**
3. The 22% Bucket: Your last bit of income (anything over $47,151) is taxed at 22%.
   • ($50,000 - $47,150) = $2,850
   • ($2,850 x 0.22) = **$627**

Your Total Federal Tax Bill: $1,160 + $4,266 + $627 = **$6,053**

Your "top" bracket is 22%, but your effective tax rate (your actual bill) is only $6,053 / $50,000 = 12.1%.

This progressive system is the same for everyone, no matter where you live.

State Tax Brackets (The Local One)

This is where everything gets complicated. Each of the 50 states gets to make its own rules.

What It Funds:

This is the money that pays for all the state and local programs you see every day:

• Public schools and state universities
• State and local police forces and fire departments
• State and local roads (the ones that aren't interstates)
• State parks, city government, and local public services

To pay for this, each state has chosen one of three different income tax systems.

System 1: Progressive State Brackets (Like Federal)

Most states (about 32 of them, including California, New York, and Georgia) copy the federal system. They have their own set of progressive "buckets" or brackets.

• Example: California. California has 10 tax brackets, ranging from 1% on your first few dollars of income all the way up to 13.3% for income over $1 million. This is one of the most progressive systems in the country.
• Example: New York. New York also has brackets, topping out at 10.9% for high earners.

If you live in one of these states, you are doing the "bucket" calculation twice: once for the IRS (federal) and once for your state.

System 2: Flat Tax

A smaller group of states (about 11 of them, including Illinois, Pennsylvania, and North Carolina) decided that was too complicated. They have a flat tax.

A flat tax means everyone pays the exact same percentage, regardless of their income.

• Example: Pennsylvania. The state income tax is 3.07%. It doesn't matter if you make $20,000 or $20 million. You pay 3.07% of your income.
• Example: Illinois. The state income tax is a flat 4.95%.

This system is much simpler to calculate, but critics argue it's unfair to low-income earners, who pay the same rate as the wealthy.

System 3: No Income Tax

This is the most famous group. Nine states have decided to not have an income tax at all.

The 9 "No-Tax" States are:

• Alaska
• Florida
• Nevada
• New Hampshire (taxes interest & dividends, but not wages)
• South Dakota
• Tennessee
• Texas
• Washington
• Wyoming

This is why so many people move to places like Florida and Texas. They get an "instant raise" because they are no longer paying any state income tax, which could have been 5% or 10% in their old state.

Wait... How Do They Fund Schools and Police?

These states aren't "tax-free." They just get their money from other places. To make up for the lack of an income tax, they typically have much higher taxes in other areas, such as:

• High Sales Tax: You'll pay a higher tax rate on everything you buy (groceries, clothes, cars).
• High Property Tax: This is the big one. States like Texas and New Hampshire have some of the highest property taxes in the entire country to fund their schools.

How Do Federal and State Taxes Interact?

This is the simplest part: They don't.

They are two completely separate tax returns that you file with two completely separate agencies.

1. You file your Federal Return (Form 1040) with the IRS.
2. You file your State Return (e.g., California Form 540) with your state's Department of Revenue.

A common myth is that what you pay in one tax can be credited against the other. This is not true.

The only major way they interact is with the SALT Deduction. "SALT" stands for "State and Local Taxes." The federal government allows you to deduct some of the money you paid to your state from your federal taxable income.

However, a 2017 law capped this deduction at $10,000 per year.

This means that if you live in a high-tax state like New York and pay $25,000 in state income and property taxes, you can only deduct $10,000 of that on your federal return. This is why you'll hear people in high-tax states complain about the "SALT cap."

The Final Breakdown: Why It Matters

For you as a new investor and wage earner, this means your total tax burden is more than just one number. It's your Federal rate + your State rate.

And, most importantly, it means that where you choose to live is one of the biggest financial decisions you can possibly make.