Federal & State Tax System in USA : Comprehensive Guide

The tax system in the United States can feel confusing, especially if you’re new to it. There are two main types of taxes Americans pay, federal taxes and state taxes. These taxes help the government provide services like roads, schools, national defense, and healthcare.

While the federal tax system is the same across the country, each state has its own tax rules. Some states charge income tax, others do not. Some have higher sales or property taxes. This blog will break down how both systems work and explain what you need to know to stay compliant and save money.

1. Federal vs. State Taxes: What’s the Difference?

Federal Taxes

These taxes are collected by the Internal Revenue Service (IRS). Everyone in the U.S. must follow federal tax rules. The money goes to fund things like:

• Social Security
• Medicare
• National defense
• Federal programs

State Taxes

Each state sets its own tax rules. State taxes help pay for:

• Schools and colleges
• Roads and transportation
• Public safety (police and fire services)
• Local healthcare and other community programs

Some states also allow local governments (like cities and counties) to add extra taxes.

2. Federal Income Tax: A Progressive System

Federal income tax is based on how much money you make. It uses a progressive tax system. This means the more you earn, the higher your tax rate.

Tax Brackets (2025 – example rates)

• 10% on the first portion of income
• 12%, 22%, 24%, 32%, 35%
• 37% for the highest earners

So, someone who earns more will pay a larger share of their income in taxes. But they still pay the lower rates on the income in lower brackets.

3. State Income Tax: Different Everywhere

Not all states have income tax. Here's how it breaks down:

States with No Income Tax

• Alaska
• Florida
• Nevada
• South Dakota
• Tennessee
• Texas
• Washington
• Wyoming

These states don’t charge income tax, but they often have higher sales or property taxes to make up for it.

States with Flat Income Tax

Some states charge everyone the same tax rate, no matter how much they earn. Examples:

• Colorado (4.4%)
• Michigan (4.25%)
• Utah (4.85%)

States with Progressive Income Tax

Just like the federal system, these states tax higher incomes at higher rates. Examples:

• California (up to 13.3%)
• New York (up to 10.9%)
• New Jersey (up to 10.75%)

4. Sales Tax: No Federal, But Most States Do

The federal government does not collect sales tax. Sales taxes are set by states and local governments.

How It Works:

• You pay a percentage on purchases (clothes, food, electronics, etc.)
• The rate can vary by city or county
• Some items may be tax-free (like groceries in some states)

Examples:

• California: Around 7.25% base + local rates
• Oregon: 0% (no sales tax!)
• Tennessee: One of the highest—up to 9.55%

5. Property Tax: Local and State Support

Property taxes are paid by people who own real estate, like homes, buildings, or land. These taxes fund public services like schools, parks, and fire departments.

Things to Know:

• Property taxes are set by local governments
• Rates vary a lot between counties
• The value of your home is used to figure out how much you owe

For example, New Hampshire has no income or sales tax, but high property tax. That’s how the state funds schools and local programs.

6. Excise Taxes: Hidden in Everyday Goods

Excise taxes are special taxes placed on specific items such as:

• Gasoline
• Tobacco
• Alcohol
• Airline tickets

These taxes exist at both the federal and state levels. You don’t always see them when you pay, but they are included in the price of the product.

7. Tax Deductions and Credits

Deductions and credits help lower the amount of tax you owe.

Federal Deductions

You can choose the standard deduction or itemize your deductions (like mortgage interest or donations). Most people take the standard deduction.

Federal Credits

• Child Tax Credit
• Earned Income Tax Credit
• Education Credits

State Credits and Deductions

Many states follow the federal system, but not all. Some offer unique credits like:

• Credits for elderly taxpayers
• Credits for solar energy use
• Deductions for retirement income

Always check your specific state’s tax website for details.

8. Filing Taxes: Federal and State Returns

Federal Filing

You file your federal taxes with the IRS using Form 1040. The due date is usually April 15.

State Filing

• You must also file a separate state return (if your state has income tax).
• Deadlines may be the same as federal, but not always.
• Some states offer free online filing systems.

If you live in one state but work in another, you may need to file returns in both states.

9. SALT Deduction: What It Means

SALT stands for State and Local Taxes. On your federal tax return, you can deduct the amount of state and local taxes you paid—but there’s a cap.

Key Rule:

• The SALT deduction is limited to $10,000 per year (as of 2025)
• This rule came from the 2017 Tax Cuts and Jobs Act
• High-tax states like California and New York have argued against this cap

10. Living in High-Tax vs. No-Tax States

Where you live can change your total tax bill. Here's a comparison:

High-Tax States

• California: High income and sales taxes
• New York: High income taxes and property taxes
• Illinois: High property taxes

No-Income-Tax States

• Texas: No income tax, but high property and sales taxes
• Florida: No income tax, lower property taxes than Texas
• Washington: No income tax, but high sales tax

When choosing where to live or set up a business, it’s important to consider all types of taxes—not just income tax.

11. What If You Live and Work in Different States?

Many people work in one state and live in another. This is common near state borders or when working remotely.

You Might Have To:

• File tax returns in both states
• Pay income tax where you work and get credit from your home state

This can be tricky, so it’s good to get help from a tax advisor or use trusted tax software.

12. Why the Tax System Matters

Understanding how taxes work helps you:

• Plan better for your financial future
• Avoid penalties and mistakes
• Use deductions and credits wisely
• Make smarter decisions about where to live or work

Taxes are not just about what you owe. They also affect how much you save and how your business runs.

Know the Rules, Make Smart Moves

The U.S. tax system includes both federal and state rules, and they work together to collect money for public services. While federal taxes are the same for everyone, state taxes can vary a lot. Some states offer big savings with no income tax, while others provide strong local services but charge more in sales or property taxes.

Understanding these differences helps you plan ahead, whether you're an individual or running a business. By knowing where your money goes, taking advantage of tax credits, and filing your returns correctly, you can stay compliant and even lower your total tax bill. Global FPO is here to help guide you through these systems and keep your tax filings smooth, correct, and on time—no matter what state you’re in.

FAQs

Q1. Do all states charge income tax?
No. Nine states, including Texas and Florida, do not charge income tax.

Q2. Can I deduct state taxes on my federal return?
Yes, but only up to $10,000 under the SALT deduction cap.

Q3. What happens if I live in one state and work in another?
You may need to file tax returns in both states, but your home state often gives you credit for taxes paid elsewhere.

Q4. Is there a federal sales tax?
No. Sales taxes are only applied at the state and local level.

Q5. When is the tax filing deadline?
Federal tax returns are due around April 15 each year. State deadlines vary slightly but often match the federal schedule.