Whereas federal taxes are uniformly applied throughout the U.S., state and local taxes introduce a wide array of obligations that vary significantly from one place to another. In the U.S., taxes can be imposed by the federal government, state governments, local governments, or any combination of these, creating a patchwork of overlapping obligations. This guide will discuss the various tax obligations you may encounter at the state and local levels. We will start with familiar taxes such as income, sales and use, excise, and property taxes, and then we will move on to less frequently encountered taxes like estate and inheritance taxes. 

Income Taxes

As of this writing, all but nine U.S. states impose taxes on the income of their residents (and, as we shall see below, nonresidents as well in some cases). For these purposes, taxable income generally includes wages, salaries, business income, investment income, and any other sources of income as defined by the laws of each jurisdiction, and a state only has the authority to tax individuals and entities with whom it has “nexus” (i.e., the connection or presence that gives a state the legal right to tax someone or something), and thus the concept of residency bears exploring in some detail. States technically have the right to tax the entire income of their residents, regardless of where the income is earned or sourced (though there are state-specific exceptions and limitations). There are two main ways a state determines residency:

• Domicile: A domiciliary state is the state which an individual considers their one true, permanent home, the place they intend to return to even after any absences. Factors considered in determining domicile include where the individual is registered to vote, has a driver's license, maintains a primary residence, has family ties, and has other significant connections.
• Physical Presence: Some states also employ a physical presence test. This means an individual is considered a resident if they are physically present in the state for a certain number of days during the tax year, with the exact threshold for physical presence varying by state.

It should be noted that, in practice, states employ various hybrid approaches by blending domicile and physical presence tests with additional criteria to determine residency.

State taxation of non-residents: Even if an individual is not a resident of a state, that state can still tax income that is sourced to that state. This means income earned within the state's borders, such as wages for work performed in the state, income from a business operating in the state, or rental income from property located in the state. For example, if an individual lives in State A but works in State B, State B can tax the income earned from employment within its borders. Similarly, if an individual owns rental property in State B, the rental income from that property is subject to State B’s taxation, regardless of the individual’s state of residence.

Property Taxes 

Property taxes are a cornerstone of local government finance, providing essential funding for schools, public services, and infrastructure and are generally assessed based on the ad valorem (according to value) value of the property. For these purposes, the taxable property may be real property, or personal property (which, based on the state, may be tangible property, intangible, or both).  

Real Property Tax: Real property tax is assessed on the value of real estate—land and any permanent structures built upon it, such as homes, commercial buildings, and industrial facilities. The power to levy real property tax with the local government where the property is physically situated, be it a county, city, town, or even a special taxing district like a school district. The physical location of the property, known as its situs, is the determining factor for which jurisdiction has the right to tax it. To determine the amount of tax owed, the local assessor's office will assess the property's value, which, depending on the jurisdiction, might be based on the property's fair market value, a percentage of its fair market value, or other valuation methods specified by state law. (Note that it is not only the rates themselves that can vary significantly by state, but also the availability and extent of exemptions, such as homestead exemptions, which reduce the taxable value of a primary residence, or exemptions for veterans, senior citizens, and more). 

Personal Property Tax: Unlike real property, personal property is movable, and encompasses items like vehicles, boats, furniture, business equipment, inventory, and livestock. As with real property, the authority to tax personal property usually rests with the state or local government where the property is located or has its situs. For these purposes, the situs of personal property is usually determined by where the property is physically located on a specific date, such as January 1st. In some cases, the situs might be where the property is habitually kept or used. The assessment of personal property can vary depending on the type of property. Vehicles might be assessed using a standardized value schedule, while business equipment might be assessed based on its depreciated value. As with real property, states will allow varying exemptions for certain types of personal property, such as household goods, business inventory up to a specific value, or farm equipment.

Intangible Personal Property Tax: Intangible personal property refers to assets that lack physical substance but hold significant value such as stocks, bonds, patents, trademarks, copyrights, and other intellectual property. Most states do not levy taxes on intangible personal property, and those that do generally tax it at lower rates than real or personal property. 

Sales and Use Taxes

Sales and use taxes are transactional taxes imposed on the sale or use of goods and services. While often grouped together, they are distinct taxes with separate purposes and rules. Sales tax is imposed at the point of sale and collected by the seller, while use tax is a complementary tax imposed on goods purchased without sales tax but used within the state. Let’s examine these in more detail: 

Sales tax is a consumption tax levied on the retail sale of tangible personal property and, in some states, specific services. 

• Taxing Authority: The power to levy sales tax resides with the states, and many states also authorize local governments (counties, cities, etc.) to impose their own sales taxes. The combined state and local sales tax rates can vary significantly across jurisdictions.
• Nexus: For a state or locality to impose sales tax on a seller, the seller must have a sufficient connection to the jurisdiction. Traditionally, physical presence (e.g., having a store or warehouse in the state) established nexus. However, following the Supreme Court's decision in South Dakota v. Wayfair, Inc. (2018), states can now require out-of-state sellers with a certain level of economic activity (e.g., sales exceeding a threshold amount) to collect and remit sales tax, even if they have no physical presence in the state.
• Taxable Transactions: Sales tax generally applies to retail sales of tangible personal property, such as clothing, electronics, furniture, and automobiles. Some states also tax certain services, like hotel stays, restaurant meals, or admissions to entertainment events.
• Exemptions: Many states exempt certain goods and services from sales tax, such as groceries, prescription drugs, and medical devices. Some states also offer sales tax holidays for specific items during certain periods.

Use tax is a complementary tax to the sales tax, and is  is imposed on the use, storage, or consumption of tangible personal property purchased without sales tax but used within the state. The purpose of the use tax is to prevent individuals from avoiding sales tax by purchasing goods from out-of-state sellers who are not required to collect sales tax. The use tax rate is generally the same as the sales tax rate in the state where the property is used. Unlike sales taxes, where the responsibility to collect it from the consumer and then remit it to the appropriate taxing authority is on the seller, the person who purchases the goods or services is required to report and pay those taxes.

Excise Taxes 

Excise taxes are levied on specific goods or services, often with the goal of discouraging their consumption or generating revenue for particular purposes. State excise taxes are usually imposed on the sale of fuel, tobacco, alcohol, motor vehicle registrations, and hotel occupancy. Furthermore, some states may impose excise taxes on specific services, such as telecommunication services, utility services, amusement and entertainment services, and transportation services.

Estate and Inheritance Taxes

Both estate and inheritance taxes are taxes imposed on the transfer of property upon a decedent’s death. Estate tax, levied at both the federal and state levels, is calculated based on the entire value of the deceased person's estate before distribution to heirs. Inheritance tax, on the other hand, is levied at the state level on each individual beneficiary's share of the estate. In other words, the beneficiaries themselves are responsible for paying this tax.

Real Estate Transfer Taxes

Also referred to as “deed transfer taxes” or “conveyance taxes,” real estate transfer taxes are levied by most states when real property changes ownership. These taxes are typically the responsibility of the seller, though some states allow for negotiation between the buyer and seller, and in a few instances, the buyer may be primarily liable. The tax rate is calculated as a percentage of the property's sale price or assessed value, varying significantly across states, from a fraction of a percent to several percent. Some states have a flat rate, while others employ tiered rates that increase with the property's value.

Payroll Taxes

Payroll taxes are mandatory deductions from employee wages and salaries, supporting essential social insurance programs. State-level programs include unemployment insurance (SUI), which provides temporary financial assistance to eligible workers who've become unemployed due to factors generally outside their control (though specific eligibility criteria vary by state); disability insurance (SDI), offering partial wage replacement for non-work-related illnesses or injuries (with potential employee contributions in some states); and workers' compensation insurance, the exclusive remedy for work-related injuries or illnesses, providing benefits to affected employees. It's important to note that federal payroll taxes, notably Social Security and Medicare (FICA), are also withheld from employee wages and matched by employers. Additionally, some states have expanded their payroll tax programs to include paid family leave and paid sick leave benefits.

Local Taxes

In addition to state-level taxes, local governments—such as counties, cities, towns, villages, and special districts—also have the authority to levy taxes, the revenue from which is used to fund essential public services like schools, police and fire departments, parks, libraries, and infrastructure. Local taxes will often overlap with federal and state taxes such that the same income, transactions, or property can be subject to multiple levels of taxation. Some common local taxes include:  

• Property Taxes: While states establish the legal framework for property taxation, the rates and administration are usually handled at the local level, as local governments are typically the primary assessors and collectors of property taxes, which they use to fund public schools, law enforcement, fire protection, and infrastructure maintenance..
• Sales Taxes: Many states allow local governments to add their own sales tax on top of the state sales tax, which can result in a combined sales tax rate that is significantly higher than the state rate alone. For example, a city might add a 1% sales tax to the state's 6% rate, resulting in a total sales tax of 7% for purchases within the city limits.

• Excise Taxes: Certain excise taxes, such as those on hotel occupancy, car rentals, prepared food, alcohol, or tobacco, may be imposed by federal, state, and local governments. The rates and applicability of these taxes can differ at each level. For example, a state might impose a 5% excise tax on hotel stays, while a city within that state might add an additional 2% hotel occupancy tax.
• Income Taxes: While less common than state income tax, some localities (e.g., New York City, Philadelphia) impose their own income taxes on residents and, in some cases, nonresidents working within the locality. Local income taxes are usually calculated as a percentage of an individual's taxable income, with rates and brackets that may differ from the state income tax.
• Special District Taxes: Special districts, which are independent local governments created to provide specific services within a defined area (including school, fire, library, and water districts) often have the authority to levy property taxes or special assessments called “special district taxes,” to fund their operations.

Note that similar to state taxes, local governments must have nexus, or a sufficient connection, to impose taxes on individuals or businesses. For local property taxes, nexus is usually established by the physical location of the property within the jurisdiction. For local sales taxes, nexus can be established by physical presence (e.g., a retail store) or economic activity (e.g., exceeding a sales threshold). Note that when a taxpayer has activities or income in multiple localities, apportionment rules may apply to determine the portion of income or sales subject to tax in each jurisdiction, and for these purposes, will generally consider factors like the location of the taxpayer's physical presence, employees, or sales.

Given that you may have more than one state vying for a share of your income, and that the same property or services can be subject to tax by not only the federal government but also multiple states and local governments, how strategically you structure your affairs can have tremendous ramifications on your tax liabilities. Through AAL’s directory, you can find many skilled attorneys with extensive experience in tax law practice who can assist you and provide you with the guidance necessary to optimize your tax position, ensure compliance with all relevant laws, and minimize your overall tax burden through strategic planning and expert advice.