Several countries with a federalist government structure divide the power between the federal government and the states. However, not all countries allow both to impose an income tax on the citizens. This case is unique to the United States. The United States, being a federal system that it is, collects tax at the federal level while also allowing the fifty states to collect tax as well. This tax is used to meet state expenditure on education, health, roads, and infrastructure.
The major differences between federal tax and state tax lies are the ways these taxes are imposed, the type of income that is taxable under each, and the tax credits and deductions allowed to the taxpayers.
Broadly, any person living in or earning from their business in any of the states is liable to pay federal tax on their income. This includes resident aliens as well. Non-resident aliens are also required to pay federal taxes on their income. On the other hand, the state income tax is for the residents of a state and is levied by the State Department of Revenue, State Treasurer, or State Comptroller.
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While federal taxes are imposed on a progressive basis on income, states follow different methods of imposing taxes. The states of Utah, Pennsylvania, North Carolina, Michigan, Colorado, Indiana, Massachusetts, and Illinois have a flat tax rate or a fair tax rate. In this, the income of individuals is taxed at the same rate regardless of their income. Interestingly, there are also states that do not impose any taxes on income. The states of Alaska, Wyoming, Texas, Florida, South Dakota, Nevada, and Washington impose zero income tax. However, the mere lack of an income tax imposed by the state does not imply that the residents do not have to pay any tax. The residents must pay sales tax, property tax, and gasoline tax, among others.
Another biggest differentiating factor between the state and federal taxes is the type of income that is taxed under this multi-tiered tax system. These differences also exist in taxes imposed by different states. Under the federal tax, retirement income is taxable. However, several states allow a partial or even a full tax exemption on retirement income. Also, interest received on US Savings Bonds is exempt from state tax, but it is subject to federal taxes. Additionally, the states of New Hampshire and Tennessee only impose a tax on income from interest and dividends and not on any other income. The state of Alabama does not impose a tax on pensions received from civil service and the government, and Connecticut allows a 50% exemption on military retirement pay.
The difference between federal tax and state tax also lies in the way tax credits are given to the taxpayer. A citizen of New York City is allowed a tax credit to the extent of one-fifth of premium paid on a long-term care insurance, while no such credit is available under federal tax.
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