Do all states have an income tax, and how do state tax laws differ from federal laws?

by | Apr 24, 2025 | Individual Taxes, State Tax Filing

Here’s what HIVE AI had to say about “Do all states have an income tax, and how do state tax laws differ from federal laws?”:

State Income Tax Landscape

Not all states impose an income tax. Currently, there are several states that do not have a state income tax on wages and salaries:

The following states do not have a state income tax:

Additionally, New Hampshire and Tennessee do not impose a general income tax on an individual’s earned income. Rather, these states tax gross interest and dividend income above certain thresholds. IRS IRM 5.19.13 Campus Procedures for Securing Financial Information New Hampshire is actually phasing out its tax on interest and dividend income.

In recent years, there have been significant changes to state income tax structures. For example, in 2023, three states—Arizona, Idaho, and Mississippi—converted from graduated-rate income tax structures to flat tax structures. Tax Foundation This represents a trend where some states are simplifying their tax systems.

Most states impose both an individual income tax and a sales tax. But of those with only one of the two, more states opt for a sales tax than an income tax—for good reason. If a state needs additional tax revenue, policymakers should bear in mind the distinct economic ramifications of each form of tax. Tax Foundation

Local Income Taxes

Beyond state-level income taxes, until 1962, only a few states—Pennsylvania, Ohio, Kentucky, and Missouri—had implemented local income taxes. Municipal income taxation was, to an extent, an Appalachian phenomenon, geographically contained. Michigan then followed in 1962, and Baltimore and New York City adopted municipal income taxes in 1966. Today, local governments in 16 states tax income in some form. Tax Foundation

For federal tax purposes, the term “State income tax” includes any local income tax administered by the chief tax administration agency of the State. IRC § 6402(e) This means that local income taxes are treated similarly to state income taxes for certain federal tax provisions.

Key Differences Between Federal and State Tax Laws

1. Constitutional Authority

Under the Constitution, Congress has the power to tax. That power was conferred subject to certain restrictions, including the requirement that “direct taxes” be apportioned among the States. This apportionment requirement created constitutional problems with an income tax, so the Sixteenth Amendment was ratified in 1913 to except a Federal income tax from that apportionment requirement. Dawson U.S. Tax Court Opinions: Northern California Small Business Assistants Inc.

The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Tax Foundation States, on the other hand, derive their taxing authority from their own constitutions and are not subject to the same constitutional limitations as the federal government.

2. Tax Base and Conformity

Despite the shortcomings of the federal government’s definition of income, states that use it reduce the tax compliance burden on taxpayers. Five states score poorly because they do not conform to federal definitions of individual income: Alabama, Arkansas, Mississippi, New Jersey, and Pennsylvania. Tax Foundation

Most states use federal adjusted gross income (AGI) or federal taxable income as a starting point for calculating state taxable income, but they often make their own adjustments. This is known as “conformity” with the federal tax code.

3. Collection Mechanisms

There is only one Federal income tax but there are two separate collection mechanisms: (1) from the employer pursuant to section 3402 or section 3403 and (2) from the employee, generally pursuant to sections 1, 61(a)(1), 6151(a), and 6155. Dawson U.S. Tax Court Opinions: Matthew L. Cutler & Shannon W. Cutler This observation also applies to state tax systems.

The Federal tax system is basically one of self-assessment. In general each taxpayer (or person required to collect and pay over the tax) is required to file a prescribed form of return which shows the facts upon which tax liability may be determined and assessed. Generally, the taxpayer must compute the tax due on the return and make payment thereof on or before the due date for filing the return. Tresuary Reg. 601.103

4. Tax Rates and Structures

States have significant flexibility in designing their tax rate structures:

  • Flat vs. Progressive Rates: Some states use a flat tax rate (everyone pays the same percentage), while others use progressive tax brackets (higher incomes pay higher percentages).
  • Tax Brackets: States with progressive tax structures set their own brackets and rates, which often differ significantly from federal brackets.

Some states are changing their tax structures. For example, Massachusetts’s individual income tax converted from a flat to a graduated-rate tax with a new rate of 9 percent on income exceeding $1 million. Tax Foundation

5. Alternative Minimum Tax (AMT)

At the federal level, the alternative minimum tax was created in 1969 to ensure that all taxpayers paid some minimum level of taxes every year. Unfortunately, it does so by creating a parallel tax system to the standard individual income tax code. AMTs are an inefficient way to prevent tax deductions and credits from totally eliminating tax liability. As such, states that have mimicked the federal AMT put themselves at a competitive disadvantage through needless tax complexity. Four states score poorly for imposing an AMT on individuals: California, Colorado, Connecticut, and Minnesota. Tax Foundation

6. Treatment of Income Types

States vary in how they tax different types of income:

All states that tax all types of income score poorly by tax competitiveness criteria. New Hampshire, which taxes individuals on interest and dividends, scores somewhat better because it does not tax capital gains. Washington scores even better on this metric because it taxes certain capital gains income but does not tax wage and salary income. Nevada’s payroll tax does not apply to capital income, and thus scores perfectly on this measure, along with states that forgo all income taxation. Tax Foundation

7. Deductions and Credits

States offer their own sets of deductions and credits that often differ from federal provisions. For example:

For federal tax purposes, taxpayers can elect to deduct state and local sales taxes in lieu of state and local income taxes. The term “general sales tax” means a tax imposed at one rate with respect to the sale at retail of a broad range of classes of items. IRC § 164(b)

8. Community Property Laws

Section 66 of the Internal Revenue Code deals with the treatment of community income. Married couples in a community-property state like California who don’t file joint tax returns “generally must report half of the total community income earned by the spouses during the taxable year.” With community income, like other income, federal income-tax liability follows ownership. And state law controls the ownership determination. Dawson U.S. Tax Court Opinions: Ann S. Carrino

9. Relationship Between Federal and State Tax Laws

New York law labels certain credits as “income tax credits,” and excesses or surpluses as “overpayments” of state income tax for state-tax purposes. But is a state’s legal label for a state-created right binding on the federal government? Here begins a disagreement. Some taxpayers contend that a state’s tax-law label is a legal interest that binds the Commissioner and the Tax Court when analyzing taxability under federal law. The Commissioner warns that if this were true, a state could undermine federal tax law simply by including certain descriptive language in its statute. Dawson U.S. Tax Court Opinions: David J. Maines & Tami L. Maines

The Treasury Department and the IRS disagree that the manner in which U.S. states determine the amount of income that is taxable in a particular state has any bearing on whether a foreign tax is an income tax in the U.S. sense. The Supreme Court has held that “in the interpretation of the words used in a federal revenue act, local law is not controlling unless the federal statute by express language or necessary implication, makes its own operation dependent upon state law.” Nothing in the Code, legislative history, or case law suggests that whether a tax is an income tax in the U.S. sense should be determined by reference to state, as opposed to Federal, income tax principles. T.D. 9959

For certain federal tax purposes, “any State or local income tax effect which is related to a Federal income tax effect shall be treated in the same manner as a Federal income tax effect.” However, “achieving a financial accounting benefit shall not be taken into account as a purpose for entering into a transaction if the origin of such financial accounting benefit is a reduction of Federal income tax.” IRC § 7701(o)

10. State Tax Refunds and Federal Taxation

In determining whether a State payment constitutes a State tax refund, as opposed to some other type of State payment, the particular label given to the payment under State law is not controlling for Federal tax purposes. Instead, Federal tax law looks to the substance of the payment to determine its purpose and Federal income tax characterization. Notice 2023-56

Practical Implications of These Differences

  • Filing Requirements: Taxpayers may need to file tax returns in multiple states if they have income from different states.
  • Tax Planning: Different state tax structures create planning opportunities and challenges.
  • Compliance Burden: Varying state tax laws increase the complexity of tax compliance for individuals and businesses operating in multiple states.
  • Economic Impact: Because a sales tax is imposed on consumption rather than labor or investment (in contrast to an individual income tax), its economic impact is smaller and collections are less volatile than under an income tax. Tax Foundation
  • Revenue Stability: Different tax structures provide varying levels of revenue stability for state governments.

Conclusion

The U.S. tax system is a complex web of federal and state laws that often interact but maintain significant differences. While the federal government imposes income taxes uniformly across the country, state approaches to taxation vary dramatically—from states with no income tax to those with complex progressive tax structures. These differences reflect each state’s unique economic priorities, political philosophies, and revenue needs.

Understanding these differences is crucial for taxpayers who may live, work, or do business in multiple states, as well as for policymakers considering tax reform. The interaction between federal and state tax systems continues to evolve, with states often responding to changes in federal tax law by adjusting their own tax codes.

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