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What is the Difference Between Federal and State Tax Laws, and How Do They Interact?

Tax Law

State Taxes: Are They All the Same?

The short answer is NO. Each state has strict tax laws that we must follow, but the types of state taxes vary significantly from state to state. However, all state taxes are some combination of the following types of taxes collected: state income taxes, property taxes, and state business taxes (e.g., sales/use tax, Franchise/Excise tax, alcohol taxes, etc.). These taxes are imposed by the state or local entities to fund necessary projects or services, like school funding, libraries, and local building projects.

Texas, for example, is one of the few states that doesn’t have personal income tax but has more than 50 other taxes they impose throughout the state, such as a franchise tax, gas tax, property tax, sales tax, and more. These different taxes allow for adequate funding for schools, municipalities, and more. Furthermore, Texas doesn’t have a corporate income tax and is one of only a handful of states that don’t require it. Low taxes, generally speaking, make Texas an appealing place for businesses to open or relocate and help them thrive.

States like Missouri impose an income tax of up to nearly 5% for their residents, and some municipalities may have an additional tax. Property and sales taxes in Missouri are average compared to other states, making the tax rates rather appealing in this state.

Tennessee combines the two previously mentioned states with some slight variations. Tennessee has no personal income tax, but a corporate income tax of over 6% currently exists.

The appearance of low taxes due to a lack of a Tennessee state income tax makes the state an appealing place for businesses to open or relocate and help them thrive. That said, what the state lacks in income taxes is collected through one of the other tax types listed in the first paragraph. For instance, Tennessee has one of the highest sales taxes in the country (when combined with the local sales tax rate in Davidson County, TN, for instance, where Nashville is located) at 9.25% as of 2024. Because one of Tennessee’s primary sources of income is the state sales and business taxes, it aggressively pursues any taxpayers who are delinquent in reporting or paying.

Every state has a separate revenue agency, usually called a “[State] Department of Revenue,” that is entirely separate from the Internal Revenue Service (“IRS”), the latter of which is what most people think of when considering taxes. State departments of revenue collect the respective state’s tax income, while the IRS collects tax money for the United States federal government. You could be required to file and can owe money to both, just one, or neither, depending on your circumstances.

I’m Considering Relocating for Better Taxes

If you are considering relocating, thoroughly review the state and local tax laws to determine whether or not the move is best for your family financially. Depending on your circumstances, there are appealing characteristics to each state’s tax laws, and these should be reviewed just as closely as other options such as schools, climate, and more. Keep in mind that just because a state does not have a state income tax does not mean it’s a “low tax” state. As stated, a few expensive purchases as a Tennessee resident in the first year can have you paying thousands of more dollars than you would in the short term compared to a state with an existent but low income tax due to Tennessee’s 7%+ sales tax rates.

You can, however, enlist the trusted help of tax professionals to determine what changes may be made to the taxes you must pay based on your exact circumstances so you can make an informed decision for your family.

Federal Taxes

As a citizen of the United States, you are also required to pay federal taxes based on your income. Unlike the states, the federal government has no sales tax or property taxes but rather only levies tax monies in a few areas – namely, the federal income tax, payroll taxes, and gift and estate taxes. The margins and tax brackets vary throughout the years, so it’s essential to work closely with your accountant or tax attorney to understand the bracket that your taxable income places you in and sufficiently pay your taxes throughout the year to avoid penalties or fines from the IRS.

The tax brackets will also vary based on whether you are the head of the household, single, or married. Understanding how you are filing and which bracket you should follow is important to ensure you are not inadvertently underpaying your taxes.

Tax Deductions: How Can I Make Them Work for Me?

One of the most effective ways to lower your taxes is to take advantage of the deductions and credits you may be eligible for. There are three places on your federal tax return to reduce your tax liability: (a) ‘above-the-line’ deduction, (b) the standard or itemized deduction, and © tax credits. Most taxpayers can benefit from a standard deduction or choose to itemize their deductions throughout the year if they have enough expenses where the itemized deduction expenses exceed the standard deduction threshold in a given year.

Whether you take the standard deduction or itemized deduction, you can deduct or write off many items relative to completing your self-employment work from the total taxes you owe. For example, if you work remotely, which has gained popularity even before the pandemic, you may be able to write off several things, such as a portion of your office space, office supplies, part of your cell phone bill, part of your work computer, take depreciation on certain items, and much more.

The current economy also nurtures the need for more of us to seek a second source of income or gig work, which can also include the options for several tax deductions.

It’s important to note that just as with state tax laws varying per state, applicable deductions can significantly vary. Hence, it’s essential to understand what you are eligible for and adhere to your state-specific deduction rules.

Speak with an experienced tax advisor to ensure that you are accounting for the correct deductions and can adequately document them moving forward for easier tax preparation. Typical examples are using various apps that can quickly scan receipts or track mileage.

What Happens if I Don’t Pay My Taxes on Time?

The Internal Revenue Service and state departments of revenue can be considered the largest debt collection entities in our country, so omitting filing your taxes, being late on payments, or underpaying your required taxes can have significant consequences.

A penalty fee of a one-time charge or more may be incurred, depending on whether or not this was the first time you were late paying your taxes. The failure to pay the penalty described is entirely separate from a failure to file penalty, which is a penalty for just filing the federal tax return late. Multiple other types of penalties exist, including a substantial understatement penalty, which can be at least 25% of the amount owed if an item missing from your return is large enough to result in a substantial underpayment or underreporting of income tax being reported.

In addition, if you continue to owe money to the federal government and do not pay, a Federal Tax Lien can be placed on you until the taxes are current. The lien would prevent you from buying real estate, obtaining a loan, or selling real estate unless gross proceeds are applied to the back tax debts. These may be placed by the IRS at any time when an individual owes at least $ 10,000 in back federal income taxes, including penalties and interest. State tax equivalent tax liens also exist separately, parallel to the IRS system, and different rules may apply.

Garnishments, or levies, can occur if you owe tax monies. A garnishment on your paycheck or bank account means that a certain amount may be removed from each paycheck or the bank account so that you are made to pay past tax debts owed.

Interest can be added to the amount owed until it’s paid back and can escalate as time passes. Interest in the IRS’ case is applied both back to the raw tax debts and to the penalties and continues to accrue over time, and generally cannot be removed by anyone, including attorneys or tax professionals, absent IRS error, so a taxpayer should consult with a competent tax professional if they have significant interest obligations on underlying tax and would struggle to pay it off.

The bottom line is there are plenty of ways to punish anyone if they aren’t paying their taxes. Avoiding them, ignoring them, or intentionally trying to skirt any taxes owed can lead to severe consequences. Some instances of intentionally failing to file tax returns or lying on a tax return and actively avoiding payments honestly due can even lead to federal criminal charges, though simply owing money to the federal government is generally not a crime.

Work with your tax professionals to ensure you follow strict laws within your state and area to avoid penalties.

How Can a Tax Attorney Help Me?

Tax attorneys are well-versed in state, local, and federal taxes and can assist you in many ways. They can help ensure that you comply with all tax laws while taking advantage of the benefits or deductions that may be available.

They also help to advise their clients on legal matters, represent them in court as necessary, and handle tax disputes.

Call our office today at 573-883-3056 to learn how we can best assist you.

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