Understanding the Difference Between State and Federal Taxes

Welcome to Understanding the Difference Between State and Federal Taxes, where we break down the key distinctions between these two tax systems to help you stay informed and compliant.

Table of Contents

INTRODUCTION

Let’s be honest—taxes aren’t exactly a favourite topic at dinner parties. But understanding how they work? That’s a game-changer when it comes to managing your money.

If you’ve ever looked at your pay check and thought, “Where is all my money going?”—you’re not alone. Two of the biggest culprits are federal income tax and state income tax. And while they might seem similar at first glance, they’re actually quite different in how they’re calculated, what they fund, and how they affect your bottom line. In this article, we’re breaking it all down—what each tax is, who collects it, how much you might owe, and what to watch out for come tax season. Whether you’re brand-new to filing taxes or just want a better handle on your pay check, you’re in the right place

State Income Tax vs. Federal Income Tax (Difference Between State and Federal Taxes)

In 2025, Americans are still navigating a two-part income tax system: federal taxes, which everyone pays, and state taxes, which depend on where you live. At the federal level, the IRS continues to use a progressive tax system, with rates ranging from 10% to 37%, slightly adjusted this year to keep pace with inflation.

Here’s a quick snapshot:

If you’re a single filer, the top tax bracket (37%) kicks in once your taxable income exceeds $626,350.
For those married filing jointly, that top rate starts at $751,600.
Standard deductions also saw a bump: $15,000 for single filers, $30,000 for married couples, and $22,500 for heads of household.

When it comes to state income taxes, there’s a lot more variety. According to the latest data from the Tax Foundation, eight states—including Florida, Texas, and Nevada—don’t tax income at all. Other states, like Colorado (4.4%), Georgia (5.39%), and Illinois (4.95%), use a flat tax rate, applying the same percentage to all taxable income. Then you’ve got states with more complex systems—California, for example, tops out at a whopping 13.3% for incomes over $1 million, the highest state tax rate in the country.

Interestingly, nine states—including Indiana, Iowa, and Nebraska—have made major changes for 2025, either reducing rates or moving toward flat tax systems. These shifts show a growing push toward simplifying taxes and, in some cases, lowering them to stay competitive.

A big area where state and federal taxes intersect is the SALT deduction (State and Local Tax deduction). Under the Tax Cuts and Jobs Act from 2017, that deduction was capped at $10,000, and that cap is still in effect through 2025. But there’s been movement: a new piece of legislation, nicknamed the “Big, Beautiful Bill”, recently passed in the Senate and could temporarily raise that cap to $40,000 for households earning under $500,000, through 2028. This would especially benefit folks in high-tax states like New York and New Jersey.

There are other big differences, too. Federal taxes are the same across the country and always follow a progressive structure. But states each do their own thing. Some tax only certain types of income—New Hampshire, for instance, only taxes dividends and interest. Others offer unique credits or exemptions. For example, Colorado gives tax relief to seniors aged 55–64, which isn’t something you’ll find in federal tax law.

With inflation pushing more income into higher brackets and states updating their own policies—some cutting taxes, others raising them—understanding how both systems work together is more important than ever. Whether you’re adjusting your withholdings, planning next year’s taxes, or trying to estimate your effective tax rate, it pays to know the rules at both the federal and state level.

In a nutshell:

Federal taxes in 2025 are still progressive, ranging from 10% to 37%, with slightly adjusted brackets and higher standard deductions.
State taxes vary widely—from no income tax at all in some states to progressive or flat-rate systems in others. California’s top rate of 13.3% remains the highest.
The SALT deduction cap of $10,000 remains in place for now, but federal legislation may temporarily raise it to $40,000 for middle-income households.

At the end of the day, if you want to avoid surprises at tax time—and maybe even save a little—talking to a tax professional or checking in with your state’s tax agency is always a smart move.

Key Takeaways

Federal Income Tax Brackets Are Still Progressive

The U.S. tax system continues to use seven marginal tax brackets for 2025: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Each rate applies only to the portion of taxable income that falls within that bracket—so moving into a higher bracket does not retroactively tax all of your income at that higher rate. For 2025, the top 37% bracket starts at $626,350 for single filers and $751,600 for married couples filing jointly, reflecting annual inflation indexing that pushed all the thresholds slightly higher than in 2024, giving many taxpayers a little more room before hitting the next bracket.

Standard Deduction Gets a Bump (and a Possible Bigger One)

Baseline 2025 IRS inflation update: Standard deduction amounts rise to $15,000 (single / MFS), $30,000 (married filing jointly), and $22,500 (head of household)—an automatic tax break that reduces taxable income before rates apply. This helps filers at all income levels, especially those who don’t itemize.

Potential/now-enacted increase under the federal “One Big Beautiful Bill” (signed July 4, 2025): The new law layers on additional increases—raising the standard deduction to $15,750 (single), $31,500 (MFJ), and $23,625 (HOH) for 2025 filings, with indexing going forward and an extra temporary bump for seniors. Because the bill was signed mid-year, taxpayers should watch for IRS implementation guidance; software updates may show the higher amounts at filing time.

Eight States Skip State Income Tax (But Read the Fine Print)

If you live (and properly establish residency) in a no-income-tax state, you won’t pay state tax on wages. In 2025, the usual “no personal income tax” list includes Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, and Wyoming. New Hampshire does not tax wage income; it historically taxed interest and dividends but has been phasing that out. Some lists also discuss Washington, which taxes certain capital gains but not wages—so whether you include it in the “no income tax” conversation depends on how you define income. Always check for sales, property, local, and specialty taxes before relocating.

Flat Tax Systems Are Spreading (and Rates Are Moving)

A growing number of states are adopting single flat income tax rates rather than multi-bracket systems—popular for simplicity and business friendliness.

Georgia: Flat 5.39% rate (2024 baseline) continues into early 2025; legislation triggers a reduction to 5.19% effective July 1, 2025, with further scheduled drops toward 4.99% if revenue targets are met.
Colorado: Standard flat 4.40% rate remains in effect; temporary reductions have occurred in recent years, and withholding guidance says 4.40% stays in place pending possible later adjustments
Indiana: Phasing down—3.05% in 2024, 3.00% beginning 2025, with future scheduled reductions toward 2.90% by 2027. (Some summaries still reference 3.05%; check current year when filing.)

California Still Tops (or Nears the Top) of the Tax Charts

California’s personal income tax system remains one of the highest in the nation for top earners. Base rates run from 1% up to 12.3%, and income above $1 million is subject to an additional 1% Mental Health Services tax, producing a top marginal rate of 13.3%. High earners in the state need proactive planning—estimated payments, timing of income, stock option strategy, and potential entity structuring all matter.

SALT Cap Relief May Be Coming (and Federal Law Just Moved)

Historically, the SALT deduction (state and local tax deduction) was capped at $10,000, limiting how much state tax high-tax-state residents could deduct on their federal returns when itemizing. A new federal law signed July 4, 2025 (“One Big Beautiful Bill”) raises the SALT cap to $40,000 for 2025, with phased annual increases and eventual income phaseouts beginning at $500,000 of MAGI. This is a major potential windfall for taxpayers in states like New York, New Jersey, and California, where property and income taxes often exceed the old cap. Watch for IRS guidance on documentation and phaseout thresholds.

State Income Tax

Definition and Purpose

What Is State Income Tax?

State income tax is money that some states collect from what you earn each year. Think of it as your state’s way of helping pay for things like public schools, police and fire departments, hospitals, and maintaining roads. It works a lot like federal income tax—but instead of going to Washington, it stays closer to home to fund state-level services.

But here’s the catch: not every state does it the same way. In fact, some states don’t charge income tax at all. Others rely on it pretty heavily. So depending on where you live, your tax bill could look very different from your friend’s in another state.

How Is It Different from Federal Income Tax?

Federal income tax is set by the IRS and applies to everyone across the country. The tax brackets, rules, and deductions are the same whether you live in California or Kansas.

State income taxes are a different story. Each state creates its own rules. Some have progressive tax systems—meaning the more you earn, the higher the percentage you pay. Others use flat taxes, where everyone pays the same rate, no matter their income level. And a few states only tax specific types of income, like interest from savings or dividends from investments.

As of 2025, this variety is even more noticeable. States are changing their tax laws to stay competitive or raise revenue, and it’s making a real difference in what you bring home. That’s why understanding how your own state handles income tax is so important—it directly affects your paycheck, your budget, and your overall financial plan.

How State Income Taxes Work in 2025

Income Sources Taxed by States

States generally tax income from wages, salaries, business profits, rental income, and investments. However, not all states tax all types of income. For instance, New Hampshire only taxes dividends and interest, not wages. In contrast, most states closely align their tax systems with federal definitions of taxable income, using your federal Adjusted Gross Income (AGI) as a starting point.

Common Deduction and Exemption Practices

State deductions and exemptions vary. Some states offer standard deductions, while others allow only itemized deductions. Many states also provide personal exemptions, though several have eliminated them in Favor of broader tax reforms. In 2025, states like Colorado and New York adjusted deductions for inflation, while others like Georgia updated eligibility for earned income and child tax credits.

Flat Tax States

As of 2025, more states have shifted toward flat income tax systems, aligning with a nationwide push for simpler and more transparent taxation. A flat tax applies the same percentage rate to all levels of income, regardless of earnings. This system contrasts sharply with progressive tax structures, where rates increase with higher income brackets.

What is a Flat Income Tax?

A flat tax system means every taxpayer pays the same rate on their taxable income. Whether someone earns $30,000 or $300,000, the tax rate remains unchanged. Advocates argue that flat taxes are fair, easy to administer, and promote economic growth by not penalizing higher earnings. Critics, however, argue that flat taxes can disproportionately affect lower-income individuals by taking a larger share of their income compared to wealthier taxpayers.

States with Flat Income Tax Rates in 2025

In 2025, the following U.S. states have adopted a flat income tax rate structure:

State	Flat Tax Rate (2025)	Notable Updates
Colorado	4.4%	Reduced slightly from 2024
Georgia	5.39%	Transitioned to flat model in 2024
Illinois	4.95%	Consistent rate since 2011
Indiana	3.05%	Among the lowest in the country
Kentucky	4.5%	Switched to flat tax in 2019
Michigan	4.25%	Constitutionally protected flat rate
Mississippi	4.7%	Full flat rate in effect from 2025
North Carolina	4.5%	Ongoing rate reductions from 2021 reforms
Utah	4.65%	Maintained a flat tax for over a decade
Arizona	2.5%	Lowest flat income tax rate in the nation

These states use flat tax systems not only to simplify tax compliance but also to attract businesses and high-income individuals seeking predictable and manageable tax liabilities.

Pros and Cons of Flat Income Tax Systems

Pros:

Simplicity: Easier to understand and file.
Transparency: Predictable liabilities.
Fairness (debated): Treats all income levels equally.
Economic growth: May encourage investment and job creation.

Cons:

Regressive effects: Lower-income earners may pay a larger share of income.
Less flexibility: Fewer built-in options for tax relief or progressivity.
Revenue impact: May reduce funds available for state services if not offset by other taxes.

In recent years, states like Iowa, Arkansas, and Nebraska have begun phasing out progressive brackets in Favor of flat taxes. This shift reflects a growing trend among conservative-led states to streamline their tax codes, making them more appealing to businesses and individuals considering relocation.

However, as the political climate shifts, future administrations could revisit these changes. Equity, budget stability, and public service funding remain key points of contention in the debate over flat taxes.

Progressive Tax States

A progressive tax system means that as a taxpayer’s income increases, the tax rate applied to that income also increases. This tiered structure is designed to distribute the tax burden more equitably across income levels, with higher earners paying a larger percentage of their income compared to lower earners.

What is a Progressive Income Tax?

In a progressive income tax system, income is divided into brackets, each taxed at a higher rate than the one below it. The more you earn, the more you pay—but only on the income that falls within each bracket. This system is based on the principle of ability to pay, ensuring essential revenue for public services while shielding low-income earners from disproportionate tax burdens.

States Using Progressive Income Tax Systems in 2025

As of 2025, the majority of U.S. states that levy income taxes use progressive tax brackets. Here are some key examples:

State	Top Marginal Rate (2025)	Applies to Income Over
California	13.3%	$1,000,000 (single) / $1,250,738 (joint)
New York	10.9%	$25,000,000 (joint)
New Jersey	10.75%	$5,000,000 (joint)
Minnesota	9.85%	$304,970 (joint)
Oregon	9.9%	$250,000 (joint)
Vermont	8.75%	$229,550 (joint)
Hawaii	11%	$200,000 (joint)

These states use multiple brackets, sometimes up to 10 or more, with lower-income residents paying as little as 1% to 3%, while high earners face rates nearing or exceeding 10%.

How Progressive State Tax Systems Work

Let’s say you live in California and earn $150,000. You wouldn’t pay 9.3% or 13.3% on the entire amount. Instead, each portion of your income is taxed at a progressively higher rate:

1% on the first bracket
2% on the next
And so on, until you hit the highest applicable bracket

Only the income within each bracket is taxed at that rate. This makes the system incremental, not exponential.

Advantages and Disadvantages of Progressive State Taxes

Pros:

Equity: Higher earners pay more, reducing income inequality.
Revenue generation: Efficient for funding public education, infrastructure, and health programs.
Flexibility: Allows adjustments in brackets to reflect cost-of-living and inflation.

Cons:

Complexity: More tax brackets can confuse taxpayers.
High burden on top earners: May encourage relocation to lower-tax states.
Volatility: Revenue is more dependent on high-income earners, risking budget gaps in downturns.

In 2025, some traditionally progressive states like Illinois and Iowa shifted to flat tax models, citing simplicity and business competitiveness. However, states like California, New York, and New Jersey have defended or expanded their progressive systems, citing the need for fair contributions from the wealthiest households.

Progressive taxation also remains a key issue in state elections, with debates entered on funding for public education, housing, and climate infrastructure.

Top Marginal Individual Income Tax Rates by State for 2025

In 2025, top marginal individual income tax rates across U.S. states vary significantly, reflecting diverse fiscal strategies and political priorities. While states like California and New York maintain some of the nation’s highest rates—topping 13.3% and 10.9% respectively—others such as Arizona and Iowa offer much lower flat rates as low as 2.5% and 3.8%. Several states, including Florida, Texas, and Nevada, impose no state income tax at all. These differences directly impact taxpayers’ overall burden and often influence decisions on residency, retirement, and financial planning.

Here are the top marginal individual income tax rates by state for 2025, highlighting where residents face the highest and lowest tax brackets:

Top Marginal State Income Tax Rates (2025)

State	Top Rate (2025)	Applies to Income Over…
California	13.30 %	$1,000,000 (single); $1,442,628 (joint)
Oregon	9.90 %	$250,000 (joint)
Minnesota	9.85 %	$276,200 (joint)
Hawaii	11.00 %	$325,000 (single)
New York	10.90 %	$25 million (joint)
New Jersey	10.75 %	$5 million (joint)
Connecticut	6.99 %	Over $1 million
Delaware	6.60 %	Over $60,000
Massachusetts	9.00 %	Over $1,000,000
Maryland	8.95 %	Highest bracket
Wisconsin	7.65 %	Highest bracket
Pennsylvania	6.86 % (flat rate)	Flat on all income
New Mexico	5.90 %	Highest bracket
Idaho	5.70 %	Flat bracket
Missouri	5.70 %	Top bracket
Michigan	4.25 % (flat)	Flat on all income
Iowa	3.80 % (flat)	Flat from 2025
North Dakota	2.90 %	Top bracket
Arizona	2.50 % (flat)	Flat on all income

Key Insights

California continues to lead with the nation’s highest top rate at 13.3%, applying to incomes over $1 million.
Hawaii (11%) and New York (10.9%) follow as other high-rate progressive states.
Progressive states like Oregon and Minnesota have top rates just under 10%, significantly above the national average.
Flat-tax states such as Arizona (2.5%) and Iowa (3.8%) offer a simple, uniform rate to all taxpayers.
No-income-tax states (e.g., Florida, Texas) are excluded from this list since top marginal rates do not apply.

Why This Matters in 2025

These wide disparities reflect different state priorities—some prioritize funding social services through progressive taxation, while others aim for economic growth or simplicity through flat rates or no income tax.
High-income residents in progressive states may face substantial tax liabilities, influencing decisions about relocation, retirement, or tax planning.
Flat-tax and no-tax states continue to attract residents and businesses, contributing to population shifts and economic development.

States With Little or No Income Tax

In 2025, several U.S. states continue to offer residents the benefit of low or no personal income taxes, making them attractive destinations for individuals seeking to reduce their overall tax burden. These states typically offset the lack of income tax with higher taxes in other areas—such as sales, property, or fuel taxes—but the absence of a state income tax can still provide substantial financial savings, especially for high-income earners and retirees.

States With No Broad-Based Income Tax in 2025

As of 2025, eight states do not levy a broad-based individual income tax:

State	Key Notes
Alaska	No income or sales tax; relies heavily on oil revenue.
Florida	No income tax; high tourist-based economy.
Nevada	No income tax; gaming and tourism revenue support the budget.
South Dakota	No income tax; depends on sales and excise taxes.
Tennessee	Fully phased out tax on interest/dividends (Hall Tax).
Texas	No income tax; high property taxes and sales tax.
Washington	No personal income tax; levies capital gains tax on high earners.
Wyoming	No income tax; revenues from mineral extraction industries.

Additionally, New Hampshire is phasing out its tax on dividends and interest income and is on track to eliminate it entirely by 2027, making it effectively a no-income-tax state in the near future.

Advantages of No-Income-Tax States

Lower overall tax burden for individuals, especially those with high salaries or retirement income.
Simplified tax filing process due to fewer state-specific regulations.
Attractiveness to remote workers and retirees looking for tax-friendly states.

Trade-Offs and Considerations

While no-income-tax states can offer immediate savings, they often compensate with higher taxes elsewhere:

Texas and Florida have among the highest property tax rates in the country.
Nevada and Washington rely heavily on sales and excise taxes, which can impact lower-income residents more heavily.
Public services like education or infrastructure may vary in quality due to different revenue structures.

The appeal of no-income-tax states continues to influence migration trends. States like Florida and Texas have seen consistent population growth, driven in part by their tax policies. Meanwhile, higher-tax states like California and New York have experienced outflows of residents, some of whom cite tax savings as a primary motivation for relocating.

Federal Income Tax in 2025

The federal income tax is the largest source of revenue for the U.S. federal government, funding national defence, Social Security, healthcare, infrastructure, education, and more. Every year, individuals and businesses must calculate and pay federal taxes based on their income, filing status, and deductions. In 2025, several key updates were made to tax brackets and standard deductions to reflect inflation and economic adjustments.

Federal Income Tax Brackets for 2025

The IRS uses a progressive tax system, meaning rates increase as income rises. For 2025, there are seven tax brackets:

Tax Rate	Single Filers	Married Filing Jointly	Heads of Household
10%	Up to $11,600	Up to $23,200	Up to $16,550
12%	$11,601 – $47,150	$23,201 – $94,300	$16,551 – $63,100
22%	$47,151 – $100,525	$94,301 – $201,050	$63,101 – $100,500
24%	$100,526 – $191,950	$201,051 – $383,900	$100,501 – $191,950
32%	$191,951 – $243,725	$383,901 – $487,450	$191,951 – $243,700
35%	$243,726 – $609,350	$487,451 – $731,200	$243,701 – $609,350
37%	Over $609,350	Over $731,200	Over $609,350

These brackets are adjusted annually for inflation, helping taxpayers keep pace with the cost of living.

Federal Taxes: Standard Deduction vs. Itemized in 2025

When preparing your federal income tax return, one of the most important decisions is whether to take the standard deduction or to itemize deductions. This choice can significantly impact your tax liability, and in 2025, updated deduction amounts and expanded itemization opportunities have shifted the decision-making landscape for many taxpayers.

What is the Standard Deduction?

The standard deduction is a flat-dollar amount that reduces your taxable income. It’s automatically available to most taxpayers and is designed to simplify filing by eliminating the need to list individual deductions.

For tax year 2025, the standard deduction amounts are:

Filing Status	Standard Deduction (2025)
Single	$15,000
Married Filing Jointly	$30,000
Head of Household	$22,500
Married Filing Separately	$15,000

Additional amounts apply for taxpayers who are age 65 or older or legally blind.

What Are Itemized Deductions?

Itemizing deductions means listing individual deductible expenses to lower your taxable income. This option is more complex but can result in greater tax savings if your itemized total exceeds the standard deduction.

Common itemized deductions include:

Mortgage interest on primary and secondary residences
State and local taxes paid (SALT) – capped at $10,000 for 2025
Charitable contributions
Medical expenses exceeding 7.5% of AGI
Casualty and theft losses in federally declared disaster areas

Standard Deduction vs. Itemized: Which Should You Choose?

Choose the standard deduction if your deductible expenses are less than your standard deduction amount.
Itemize deductions if your qualifying expenses exceed the standard deduction or if you’re eligible for significant write-offs like large charitable gifts or high mortgage interest.

In 2025, with higher standard deduction thresholds, fewer taxpayers benefit from itemizing. However, homeowners, high earners in high-tax states, and donors may still save more by itemizing.

Important Considerations for 2025

The SALT deduction cap remains at $10,000, though a new proposal seeks to raise this limit for certain taxpayers through 2028.
The medical expense threshold continues to be 7.5% of adjusted gross income, meaning only expenses above that level can be deducted.
Married couples filing separately must both either itemize or take the standard deduction—they can’t split.

State Income Tax vs. Federal Income Tax: 2025 Example

Scenario:

Taxpayer: Jane, a single filer
Annual Salary: $100,000
Location: California (a high-income-tax state)
Tax Year: 2025
Assumptions: Jane takes the standard deduction and has no other income, credits, or major deductions.

Step 1: Federal Income Tax (2025)

Standard Deduction (Single Filer): $15,000

Taxable Income: $100,000 – $15,000 = $85,000

Federal Tax Brackets for 2025 (Single Filers):

10% on first $11,600 = $1,160
12% on $11,601–$47,150 = $4,264
22% on $47,151–$85,000 = $8,320

Total Federal Income Tax:

$1,160 + $4,264 + $8,320 = $13,744

Step 2: State Income Tax (California, 2025)

Standard Deduction (CA): $5,202

Taxable Income (CA): $100,000 – $5,202 = $94,798

California Tax Brackets (2025, Single Filer):

1% on first $10,412 = $104
2% on $10,413–$24,684 = $286
4% on $24,685–$38,959 = $572
6% on $38,960–$54,081 = $908
8% on $54,082–$68,350 = $1,146
9.3% on $68,351–$94,798 = $2,469

Total State Income Tax (CA):

$104 + $286 + $572 + $908 + $1,146 + $2,469 = $5,485

Combined Tax Liability (2025):

Federal Income Tax: $13,744
State Income Tax (California): $5,485
Total Income Tax Owed: $19,229

Key Takeaways from the Example:

Jane owes more to the federal government than to the state.
California’s progressive tax brackets increase her burden compared to a flat-tax or no-tax state.
In a no-income-tax state like Florida or Texas, Jane would still owe the $13,744 in federal taxes, but $0 in state tax, saving her nearly $5,500.

Conclusion

If you’re trying to make the most of your money in 2025, it’s important to understand how state and federal income taxes work—and how they affect your paycheck. Here’s the thing: while federal taxes are the same for everyone in the U.S., your state taxes can be a totally different story depending on where you live.

At the federal level, we all follow a progressive tax system. That means the more you earn, the higher percentage you pay on that chunk of income. But when it comes to state income tax? It’s all over the map. Some states charge nothing at all, while others—like California—have rates that climb above 13% for top earners. That difference can have a huge impact on your bottom line, especially if you’re considering relocating or retiring.

And 2025 isn’t just business as usual. A lot is shifting. Several states have switched to flat tax systems, SALT deduction limits are still a hot topic, and the standard deduction keeps changing. Whether you’re working full-time, running your own business, or living on a retirement income, these tax rules can shape how much you owe—or save. So, what’s the smart move? Stay in the loop. Keep tabs on new tax laws, look into your state’s latest policies, and—when in doubt—talk to a tax pro. A little planning can go a long way toward lowering your tax bill, boosting your deductions, and helping you choose a place to live that lines up with your financial goals