State and Federal Taxes: How the Two Layers Fit

Most of this book is about the federal return, but most Americans file two, and some file three or more. State income tax runs on its own rules, rates and deadlines, and where you live, work and move can change your total bill as much as any federal strategy. This chapter explains how the state layer is built, how it interacts with federal tax, the residency rules that decide which state can tax you, and why the income tax rate alone is a poor guide to what a state really costs.

Two systems with separate rules

The federal government and each state tax income independently. Each has its own brackets, deductions and credits, and paying one does not settle the other. Cities and counties in some states add a third layer.

States fall into three broad groups:

• No tax on wages. Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming do not tax wage income. Washington does tax some large capital gains.
• A flat rate. A single rate applies to all taxable income, usually after a state standard deduction or exemption.
• Graduated rates. Brackets like the federal ones, with rates that rise with income.

Rates have been changing quickly. Several states cut their rates or moved to a flat tax in recent years, and some changed their law for 2026 after the year had begun. Check your state's revenue department for the current year rather than relying on an older table.

How the two layers interact

Most states start their calculation from your federal adjusted gross income and then add or subtract items. That has two consequences.

Federal moves often carry over. A pre-tax 401(k) contribution, a traditional IRA deduction or a business expense that lowers your federal AGI usually lowers your state income too.

But not always. States decide for themselves whether to follow federal changes, a question called conformity. California and New Jersey, for example, tax contributions to health savings accounts that are tax-free federally. States also differ on whether they follow the new federal deductions for tips and overtime. Many states give their own breaks the federal return does not, such as deductions for contributions to the state's 529 college savings plan.

Some income is treated differently by law:

• Interest on US Treasury securities is taxable federally but exempt from state income tax under federal law.
• Municipal bond interest is free of federal tax, but usually taxable by your state if the bond was issued by another state.
• Social Security benefits are exempt from income tax in most states, though a few tax part of them for higher-income residents. Treatment of pensions and retirement account withdrawals varies widely.
• Capital gains are usually taxed by states as ordinary income, without the lower federal rates from chapter 3.

The federal return gives something back for state taxes, but only if you itemize. State and local income or sales tax and property tax together are deductible up to $40,400 per return in 2026, a cap that applies to single filers and married couples alike. Anyone taking the standard deduction gets no federal benefit for state taxes at all.

Your combined marginal rate

For decisions about extra income, the number that matters is the total of every layer on your next dollar.

A single filer with $100,000 of wages pays $13,170 in federal income tax, an effective rate of 13.2%, but the next dollar is taxed at 22.0%. Add the employee's 6.2% Social Security tax and 1.45% Medicare tax, and a state with a 5% rate on that dollar, and close to 35 cents of the next dollar earned goes to tax. In a state with no wage tax, the same dollar loses about 30 cents. The state income tax comparison computes the state layer for every state at your income.

Residency: which state can tax you

Your state of residence can tax all your income, wherever it was earned. Any other state can tax only the income you earned there, as a nonresident. To prevent double taxation, your home state usually gives a credit for income tax paid to the other state on the same income.

Residency is decided in two main ways:

• Domicile is your true, permanent home: where you intend to return. You have only one at a time, and changing it means actually moving your life, not just your mailing address.
• Statutory residency. Many states also treat you as a resident if you keep a home there and spend more than a set number of days in the state, commonly 183, even if your domicile is elsewhere.

Moving mid-year usually means filing a part-year resident return in both states, splitting income by when it was earned.

Working across a state line. Some neighboring states have reciprocity agreements, so you pay only your home state on wages earned in the other. Without one, you file in both and claim the credit.

Remote work. A few states, New York the best known, apply a "convenience of the employer" rule: if your employer is based there and you work from home in another state for your own convenience, your wages can still be taxed as if earned in the employer's state.

If you move to a lower-tax state, expect your former state to look at the move closely, especially if you keep a home there. Records that support the move include a new driver's license, voter registration, a home in the new state, where your doctors and memberships are, and a log of the days you spend in each state.

Total burden, not just income tax

States raise money in different ways. One with no income tax may rely more on sales tax, property tax or fees, and one with a high income tax may have lower property tax. Local income taxes apply in some cities and counties, for example in parts of Ohio, Pennsylvania and Maryland and in New York City.

What a state costs you depends on how your money flows: a high earner who rents pays mostly income tax, while a retiree with a valuable home and modest income may pay mostly property and sales tax. Compare total burden, on your own income and spending, before treating a low income tax rate as a reason to move. Housing, insurance and other living costs often outweigh the tax difference.