The United States has a multi-layered income tax system. That means taxes are imposed by federal, state, and local governments. Federal and state income taxes are similar in that they apply a tax rate to taxable incomes. Indiana counties impose their respective county tax rate on the same income level as the state. However, they can differ considerably with respect to those tax rates and how they’re applied. Also, there are differences in the types of incomes that are taxable, the deductions and tax credits that are allowed.
State Income Taxes
State income tax rates vary considerably from state to state. Seven states; Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming have no income tax at all. Two states, New Hampshire and Tennessee, tax only interest income and dividends.
All other states have either flat or progressive income tax systems.
A flat system is a single rate that applies to all levels of income. Eight states, including Indiana (3.23%), use this system. The other seven are: North Carolina (5.499%), Massachusetts (5.10%), Utah (5%), Colorado (4.63%), Michigan (4.25%) Illinois (3.75%), and Pennsylvania (3.07%). Indiana counties also impose a county income tax rate. It varies from county to county. The tax imposed depends upon your county of residency and employment as of January 1 each year.
The remaining 33 states tax income using marginal, progressive systems where higher levels of income are taxed at a greater percentage. Each “bracket” of income is taxed at a higher percentage. Some states base their brackets on the federal tax code, but many states implement their own. Some adjust their brackets annually to keep pace with inflation while others do not.
Federal Income Tax
The Internal Revenue Code (IRC) governs federal income tax in the United States, and the IRC underwent some significant changes in 2018 with the passage of the Tax Cuts and Jobs Act (TCJA). The U.S. continues to implement a progressive tax system. There are seven tax brackets and marginal tax rates at the federal level: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The top rate of 37% kicks in at $510,300 in taxable income.
The federal government annually adjusts various tax breaks and tax brackets for inflation.
Other income tax considerations
In the federal tax system, taxpayers claim a standard deduction, or itemize deductions, but they can’t do both. Standard deductions increased considerably in 2018 under the TCJA. As of 2019, they’re set at $12,200 for single taxpayers, $18,350 for head of household filers, and $24,400 for married taxpayers filing joint returns. Indiana permits a deduction of $1,000 for each personal exemption.There are additional allowances for children, students and taxpayers age 65 and older.
Another difference is that retirement income is fully taxable by federal tax authorities. However, a number of states partially or fully exempt retirement income from taxation. There are differences with respect to taxing bond interest as well. For example, interest received on U.S. savings bonds is subject to federal taxation but is exempt from state tax.
There are also differences with respect to tax credits. Federal law allows several tax credits, such as for education expenses, retirement savings, and dependent care expenses. Review your particular state to determine if it provides a tax credit for these expenses. Additionally, states provide tax credits for certain expenses that are not allowed under the federal system. One credit allowed in Indiana is a 20% credit (up to $1,000) for amounts contributed to Indiana 529 Plans.
As you can see, income tax calculations are quite complex. Each tax return is unique to the taxpayer. That is the reason you should work with a tax professional when it comes to taxes. An advisor will help you make sure you take advantage of all tax exemptions and credits that are available for you. In addition, you get guidance on how best to structure your investments and retirement savings so they best serve you. If you have any questions, get in touch with me.
Dan