Even in the land of the free, making a living can be complicated and a bit costly. The United States operates a multi-tiered tax system with taxes levied at the federal, state, and local levels. Each level of taxation serves a different purpose, and taxpayers often find themselves dealing with a variety of taxes depending on where they live and work.

When you are embarking on financial planning and managing your tax obligations, it is important to discern between different levels of taxation and their impact on your overall financial health.

Below we provide a comprehensive breakdown of federal, state, and local taxes, and discuss the various types, rates, and how they affect taxpayers.

Federal taxes

At the top of the U.S. tax hierarchy are federal taxes, which are levied by the national government. Federal taxes fund a wide range of programs, including defense, healthcare, infrastructure, and social services. The most significant of these taxes is the federal income tax, which applies to individual and corporate earnings.

Federal income tax rates are progressive, meaning the rate increases as your income increases. In 2023, the tax brackets for individuals ranged from 10% for the lowest earners to 37% for the highest earners. According to the Congressional Budget Office, half of federal tax revenue comes from individual income taxes.

Lastly, 36% comes from payroll taxes, which fund Social Security and Medicare. In recent years, corporate tax rates have been a topic of debate, as the federal corporate tax rate dropped from 35% to 21% thanks to the Tax Cuts and Jobs Act of 2017.

State taxes

In addition to federal taxes, most U.S. citizens are subject to state taxes. State taxation systems can vary significantly from one state to another, with some relying heavily on income taxes while others depend on sales taxes. As of 2024, nine states do not impose a state income tax, including Florida, Texas, and Washington.

However, these states typically make up for the shortfall with higher sales taxes or property taxes.

For states that impose income taxes, rates can range widely. California has the highest state income tax rate in the U.S., with top earners charged 13.3%, while North Dakota taxes income at just 2.9%. The Tax Foundation found that the average state and local tax burden across the U.S. was 11.2% of personal income. At 12%, the state of New York has the highest overall tax burden.

Additionally, many states can impose additional taxes on specific goods, such as gasoline, tobacco, and alcohol. For example, the average state excise tax on gasoline is just over 32 cents per gallon. States like California tend to impose rates significantly higher than the national average.

Local taxes

Local taxes, which are usually imposed by counties, municipalities, or school districts, provide revenue for services like public education, law enforcement, and infrastructure. Local governments often rely on property taxes as their primary revenue source, although some localities also impose income and sales taxes.

Today’s median property tax rate falls between 0.2-1.9%, and varies widely by state. New Jersey has one of the highest property tax rates at 2.5%, while states like Hawaii enjoy much lower rates, averaging just 0.29%. According to the Tax Policy Center, property taxes alone generated over $630 billion in revenue for local governments in 2021.

In some areas, local governments also impose sales taxes on top of state rates. A 2023 report from the Tax Foundation showed that the average combined state and local sales tax rate was 7.35%, with states like Tennessee and Arkansas having combined rates exceeding 9.5%. These taxes can significantly impact consumer spending, particularly in areas with high rates.

Payroll Taxes

Payroll taxes are another key component of the U.S. tax system. These taxes are used to fund Social Security, Medicare, and federal unemployment insurance. Payroll taxes are typically split between employers and employees.

As of 2024, employees pay 6.2% of their earnings in Social Security tax (on income up to $160,200) and 1.45% in Medicare tax, with employers matching these contributions.

In 2023, Social Security and Medicare taxes generated over $1.3 trillion, or about 37% of total federal tax revenue. However, individuals earning more than $200,000 ($250,000 for married couples) are subject to an additional 0.9% Medicare surtax on income above these thresholds, which further increases the tax burden for high-income earners.

Payroll taxes can be seen as somewhat regressive because they apply only to wages and salaries, meaning that investment income or capital gains aren’t subject to these taxes. This creates a higher proportional burden for middle-class wage earners compared to those whose income comes primarily from investments.

Capital gains and dividends taxes

The U.S. tax system also includes specific taxes on capital gains and dividends. These taxes apply to income earned from the sale of investments (like stocks or real estate) and dividends paid by corporations to their shareholders.

Capital gains are taxed differently depending on whether the asset was held for more or less than a year. Long-term capital gains, on assets held for over a year, are taxed at preferential rates of 0%, 15%, or 20%, depending on your income level. In fact, some critics argue that preferential treatment of capital gains income disproportionately benefits wealthy taxpayers.

Dividend income is also taxed at either ordinary income tax rates or, in the case of qualified dividends, at the lower capital gains rates. This tax structure incentivizes long-term investment and can have significant implications for high-income earners.

Understanding different taxation levels in the U.S.

For most of us, paying taxes is an inevitable fact of life. However, understanding the different levels of taxation in the U.S. is crucial for effectively managing your financial obligations. Each level of taxation plays a vital role in funding public services and programs, which are unable to run without the inclusion of federal income taxes and state-specific tax structures.

If you need expert assistance when filing your taxes, you can feel confident working with David’s Family CPA. We guide you step by step.