Is state/federal taxable income affected by federal/state tax?

Question

While reading a recent question about tax brackets and its currently accepted answer, I realized that I do not know how the federal tax affects the taxable income for the state tax return or vice versa. I am a resident of a state that has no state income tax, so I do not have personal experience with this matter.

As in the tax bracket question, let's assume I am single and my taxable income is $100,000.

According to the 2016 IRS table for single filers:

| Taxable Income     | Tax Rate                                           |
|--------------------|----------------------------------------------------|
| $0—$9,275          | 10%                                                |
| $9,276—$37,650     | $927.50 plus 15% of the amount over $9,275         |
| $37,651—$91,150    | $5,183.75 plus 25% of the amount over $37,650      |
| $91,151—$190,150   | $18,558.75 plus 28% of the amount over $91,150     |
| $190,151—$ 413,350 | $46,278.75 plus 33% of the amount over $190,150    |
| $413,351—$415,050  | $119,934.75 plus 35% of the amount over $413,350   |
| $415,051 or more   | $120,529.75 plus 39.6% of the amount over $415,050 |

In the tax bracket question, the author lived in California, whose 2016 tax table for single filers looks like this:

| If the taxable income is                                             |
|----------------------------------------------------------------------|
| Over     | But not over | Tax is                    | Of amount over |
|----------|--------------|---------------------------|----------------|
| $0       | $8,015       | $0.00        plus  1.00%  | $0             |
| $8,015   | $19,001      | $80.15       plus  2.00%  | $8,015         |
| $19,001  | $29,989      | $299.87      plus  4.00%  | $19,001        |
| $29,989  | $41,629      | $739.39      plus  6.00%  | $29,989        |
| $41,629  | $52,612      | $1,437.79    plus  8.00%  | $41,629        |
| $52,612  | $268,750     | $2,316.43    plus  9.30%  | $52,612        |
| $268,750 | $322,499     | $22,417.26   plus  10.30% | $268,750       |
| $322,499 | $537,498     | $27,953.41   plus  11.30% | $322,499       |
| $537,498 | AND OVER     | $52,248.30   plus  12.30% | $537,498       |

I can see at least three ways to calculate my taxes.

A. Federal and state taxes use the same taxable income:

1. In the first table, I look up $100,000 and find that I should pay $18,558.75 + 0.28 * ($100,000 - $91,150) = $21,036.75 in federal taxes.
2. In the second table, I look up $100,000 and find that I should pay $2,316.43 + 0.093 * ($100,000 - $52,612) = $6,723.51 in state taxes.

B. Federal is calculated first, and state uses federal taxable income minus federal taxes:

1. In the first table, I look up $100,000 and find that I should pay $18,558.75 + 0.28 * ($100,000 - $91,150) = $21,036.75 in federal taxes.
2. In the second table, I look up $100,000 - $21,036.75 = $78,963.25 and find that I should pay $2,316.43 + 0.093 * ($78,963.25 - $52,612) = $4767.10 in state taxes.

C. State is calculated first, and federal uses state taxable income minus state taxes:

1. In the second table, I look up $100,000 and find that I should pay $2,316.43 + 0.093 * ($100,000 - $52,612) = $6,723.51 in state taxes.
2. In the first table, I look up $100,000 - $6,723.51 = $93,276.49 and find that I should pay $18,558.75 + 0.28 * ($93,276.49 - $91,150) = $19,154.17 in federal taxes.

Which of these, if any, is the correct calculation method? That is, how do federal taxes affect state taxable income or vice versa? Or is this state-dependent?

Answer 1

Federal taxes are not deductible federally, and are deductible from state taxes in six states, but not California. State and Local taxes are deductible from Federal if you itemize your deductions.

The way to do that according to Publication 17 is to deduct the amount of state/local tax has been withheld from your pay over the year (or estimated tax payments). You'll get a 1099-G for any refund that was due, which you'll have to declare on the following year's tax return.

Your "scenario C" is closest, although your taxable income will likely be different between state and federal since there are different deductions at each level.

Answer 2

I see that @pwcnorthrop says that in Alabama, federal taxes are deductible on your state return. I've never lived in Alabama so I don't know anything about this. In the states where I've lived (New York, Ohio, Pennsylvania, and Michigan), federal taxes are not deductible on your state return, and what you pay in federal taxes has nothing to do with what you pay in state taxes.

If you itemize deduction, you can deduct your state taxes from your income when calculating your federal taxes.

To avoid a paradox where you have to know what your state taxes are before you can calculate your federal taxes AND you have to know what your federal taxes are before you can calculate your state taxes -- a paradox which would no doubt result in the universe collapsing into a black whole -- you don't deduct your state taxes for this year. You deduct the amount that was withheld this year, plus any additional amount you paid LAST year. If you got a refund, the refund counts as income. (But only if you itemized last year. If you never claimed a deduction for the state taxes, you don't have to pay if you got a refund of the amount you deducted.)

So you are supposed to do your federal taxes first. Many states use a line from the federal tax form as the starting point for your state tax form and just make a (relatively) few adjustments to that, like subtracting income earned in another state, so that the state doesn't have to have to reproduce a bunch of the federal rules.

So like if in 2016 you had $1,000 withheld and had to pay an additional $100, and then in 2017 you had $1,200 withheld and had to pay an additional $200, at the time you did your 2017 federal taxes you wouldn't know yet that you have to pay the state that extra $200. For your state taxes you'd take the $1,200 withheld plus the $100 extra you paid last year, so you'd put your state taxes down as $1,300.