Federal, State & Local Taxes
Who taxes what, and why it matters for your business.
Educational content — not tax advice. Rules change; consult a professional for your situation.
Why This Matters
When ABC Coffee Shop's owner sits down in April to "file taxes," she is not filing one return. She may file:
- A federal return (Form 1040 + Schedule C) to the IRS.
- A state income tax return to her state's revenue department.
- Monthly sales tax returns to the state.
- A county property tax bill paid to the local assessor.
- Payroll tax deposits to both federal and state agencies.
The U.S. tax system is not one system — it is a layered set of independent but overlapping tax systems administered at three levels of government.
Understanding who collects what — and why — directly affects how businesses are taxed, how compliance works, and where tax-saving opportunities exist.
Why Three Levels of Government?
The United States is a federal system, meaning authority is divided between federal, state, and local governments — each with its own taxing authority, expenditure responsibilities, and revenue needs.
Federal
National functions — defense, Medicare/Medicaid, Social Security, interstate commerce. Revenue: income + payroll taxes.
State
State functions — universities, highways, state courts, Medicaid co-payments. Revenue: income tax + sales tax + gas taxes.
Local
Local functions — K-12 schools, police/fire, libraries, water, sanitation. Revenue: property tax (core local revenue).
The Federal Tax System
The federal government relies almost entirely on income as its tax base. There is no federal sales tax and no federal property tax in the United States.
FEDERAL REVENUE (approximate):
Individual income taxes: ~49%
Payroll taxes (SS + Medicare): ~35%
Corporate income taxes: ~9%
Excise taxes: ~3%
Estate, gift, customs: ~4%
| Tax | Who Pays | Rate / Structure | Form |
|---|---|---|---|
| Individual income tax | All earners | Progressive 10%–37% (2025) | 1040 |
| Corporate income tax | C-corporations | Flat 21% (TCJA 2017) | 1120 |
| Self-employment tax | Self-employed | 15.3% on net SE income | Schedule SE |
| FICA (employee) | Employees | 7.65% (6.2% SS + 1.45% Medicare) | W-2 |
| FICA (employer) | Employers | 7.65% match | Form 941 |
| FUTA | Employers | 6.0% on first $7,000 (net: often 0.6%) | Form 940 |
| Excise taxes | Varies | Per unit or % (fuel, alcohol, tobacco) | Various |
The IRS: Role and Scope
The Internal Revenue Service (IRS) administers and enforces the Internal Revenue Code. Key functions include processing ~260 million returns annually, auditing for compliance, collecting unpaid taxes, issuing guidance (regulations, Revenue Rulings), and administering refunds.
For accountants: IRS guidance is not always the last word — tax courts may interpret the law differently.
State Tax Systems
State tax structures differ dramatically. There is no single "state tax." Each of the 50 states has its own rules.
No state income tax (9 states):
AK, FL, NV, NH (wages), SD, TN (wages), TX, WA (wages), WY
Flat income tax:
IL 4.95%, MI 4.05%, PA 3.07% (13 states total)
Progressive brackets:
CA 1%–13.3% (highest), NY 4%–10.9%, most others 2%–7%+
Highest combined sales tax:
TN ~9.6%, LA ~9.5%, AR ~9.4%
Why State Tax Matters for Business Location
Texas
- • No state income tax on profits
- • Sales tax: 6.25% + up to 2% local = 8.25%
- • No corporate income tax for pass-throughs
California
- • State income tax: up to 13.3%
- • Corporate: 8.84% minimum franchise tax
- • Sales tax: 7.25% + local = 9%–10.25%
- • $200K profit → $26,600+ state income tax alone
State Sales Tax & Nexus
Sales tax is primarily a state (and local) revenue tool. Nexus determines which states you owe sales tax to — expanded by South Dakota v. Wayfair (2018) to include economic nexus ($100,000+ in sales or 200+ transactions).
SALES TAX NEXUS EXAMPLE:
ABC ships cold brew to 12 states. In 4 states, ABC exceeded the economic nexus threshold. ABC must register, collect state + local sales tax, file returns, and remit on schedule. Failure = penalties, back taxes, and interest.
Local Tax Systems
Local governments rely primarily on the property tax as their foundational revenue source.
Property Tax Mechanics
Step 1: ASSESSMENT
Local assessor estimates fair market value. Many jurisdictions assess at less than 100% of FMV (e.g., 80%).
Step 2: MILL RATE
"Mill" = $1 per $1,000 of assessed value. 20 mills = 2%.
Step 3: CALCULATE
Assessed value × mill rate ÷ 1,000 = property tax due
ABC: $350,000 × 85% = $297,500 assessed × 22 mills = $6,545/year
Local Income Taxes
| City | Rate |
|---|---|
| New York City | 0.83%–3.876% |
| Philadelphia | 3.75% / 3.44% non-res |
| Columbus, OH | 2.5% |
| Kansas City, MO | 1% earnings tax |
NYC business with employees: federal up to 37% + NY state up to 10.9% + NYC up to 3.876% = potentially 50%+ marginal rate on high income.
Special District Taxes
- School districts: Often levied as property taxes.
- Transit districts: Sales tax surcharges (e.g., Chicago RTA).
- Business Improvement Districts (BIDs): Additional assessments on commercial property.
Stacked Tax Layers — Federal + State + Local
Model ABC Coffee Shop's annual tax obligations across all three government levels. Adjust income, sales, and property inputs to see how layers stack — income taxes at each level, sales tax collected, and property tax assessed locally.
22% on $200,000.00 profit
5% on $200,000.00 profit
8% on $500,000.00 sales
1% on $200,000.00 profit
22 mills on $297,500.00 assessed
| Tax Layer | Type | Annual Amount |
|---|---|---|
| Federal | Income tax | $44,000.00 |
| State | Income tax | $10,000.00 |
| State | Sales tax (collected & remitted) | $40,000.00 |
| Local | Income tax | $2,000.00 |
| Local | Property tax | $6,545.00 |
| TOTAL ANNUAL TAX OBLIGATIONS | $102,545.00 | |
Property Tax Formula
Assessed Value = Market Value × Assessment Ratio
Property Tax = Assessed Value × Mill Rate ÷ 1,000
$350,000.00 × 85% = $297,500.00 assessed × 22 mills = $6,545.00/year
Mapping All Taxes: A Complete View for a Business
FEDERAL:
☐ Individual income tax (Schedule C) — April 15
☐ Self-employment tax (15.3%) — April 15
☐ Estimated quarterly payments
☐ FICA employer portion — per IRS schedule
☐ FUTA — Form 940
☐ Excise taxes (fuel, if applicable)
STATE:
☐ State income tax · ☐ Sales tax (monthly/quarterly)
☐ SUTA (quarterly) · ☐ Corporate minimum tax
LOCAL:
☐ Property tax (2 payments/year) · ☐ Business license tax
☐ Local sales tax · ☐ Local income tax (if applicable)
This is not unusual complexity — it is the reality for any small business operating in the U.S.
Tax Calendars: Why Timing Matters
January
Jan 15: Q4 estimated tax · Jan 31: W-2s & 1099-NEC
April
Apr 15: 1040 + Q1 estimated · Apr 30: Q1 Form 941
June
Jun 15: Q2 estimated tax payment
September
Sep 15: Q3 estimated · S-corp/partnership extensions
October
Oct 15: Extended individual returns due
December
Year-end planning: accelerate deductions, defer income
Double Taxation and Entity Selection
C-Corporation: Double Taxation
Corp earns $100,000 profit
21% corporate tax: $21,000 to IRS
After-tax: $79,000
Dividend tax (~15%): ~$13,000
Total: ~$34,000 on $100K
Pass-Through: Single Tax Layer
Profits pass to owner's personal return
Owner pays income tax once at individual rates
No second layer on distributions
Note: Still subject to SE tax on net SE income
This is why most small businesses avoid C-corp status. ABC Coffee Shop, organized as a sole proprietor or S-corp, pays tax only once on profits.
Tax Fundamentals Section Complete
You've finished the first three topics in the Tax pillar. Here's what you covered:
| # | Topic | Key Concepts | Status |
|---|---|---|---|
| #104 | How Taxes Work | Tax base, rate, liability; income/transaction/wealth objects; pay-as-you-go | Complete |
| #105 | Progressive, Regressive & Proportional | Brackets, marginal vs. effective rates, sales tax regressivity | Complete |
| #106 | Federal, State & Local Taxes | Three government layers, property tax, nexus, double taxation | Complete |
Key Takeaway
The U.S. tax system is a three-layer structure: federal (primarily income and payroll), state (income and sales), and local (primarily property). Each level has independent authority, different tax bases, and different rates. No two states have identical tax structures, which makes multi-state business operations a tax planning issue, not just a logistics issue. Small businesses like ABC Coffee Shop may face obligations to five or more separate tax authorities simultaneously, spanning income tax, payroll tax, sales tax, property tax, and local levies.
Test Your Understanding
School funding, sales tax nexus, and double taxation — check your answers below.
Question 1: Which level of government is the PRIMARY source of funding for K-12 public schools in most U.S. states?
Question 2: A business makes online sales to customers in 15 states. In which states must it collect and remit sales tax?
Question 3: ABC Coffee Shop is organized as a C-corporation and earns $150,000 in profit. It pays corporate income tax, then distributes the remaining profit to the owner as a dividend. This situation is an example of:
Ready to Practice?
Reinforce payroll liabilities, property accounting, and multi-jurisdiction compliance concepts in the Practice Lab.
Try the Practice LabWhat's Next?
Gross Income & Taxable Income — Moving from the structural overview into the mechanics of what counts as income, what reduces it, and how to arrive at the number that actually gets taxed.
Gross Income vs Taxable Income
From total earnings to the amount that is actually taxed
Progressive, Regressive & Proportional
Three rate structures and bracket mechanics