The United States has a multi-layered and complex tax system but it’s also highly structured. For individuals and businesses looking to operate in the U.S., understanding how federal, state, and local taxes work is essential for staying compliant and maximizing benefits.
In this guide, the experts at Marsan Akguc Law Firm break down how the U.S. tax system functions across all levels.
The Difference Between Federal, State, and Local Taxes
The U.S. tax system operates at three main levels:
- Federal Taxes: Managed by the Internal Revenue Service (IRS), these taxes apply to all U.S. citizens and legal residents. Common federal taxes include income tax, corporate tax, and Social Security/Medicare taxes.
- State Taxes: Each state has its own tax laws and rates. Some states like Florida and Texas do not impose personal income tax, while others like California and New York levy higher rates.
- Local Taxes: City or county governments may charge additional taxes, such as local sales tax, property tax, or special assessments.
Because of this layered system, where you live or incorporate your business can significantly affect your total tax liability.
How the Income Tax System Works for Individuals
The U.S. uses a progressive income tax system for individuals meaning tax rates increase as income increases. However, only the income within each tax bracket is taxed at that rate, not your total income.
Additional key points:
- U.S. citizens and Green Card holders must report their global income to the IRS.
- Annual tax returns are due by April 15 each year.
- Deductions, tax credits, and exemptions may lower your taxable income.
If you live abroad, tax treaties between the U.S. and certain countries may prevent double taxation.
How Corporate Taxes Are Structured in the U.S.
Corporate tax obligations in the U.S. vary depending on the business structure:
- LLC (Limited Liability Company): Often treated as a pass-through entity where profits/losses pass to the owners’ personal tax returns.
- C-Corp: Subject to double taxation the company pays corporate income tax, and shareholders pay tax on dividends.
- S-Corp: Designed for small businesses, allowing income to pass through to owners, avoiding corporate-level tax.
While the federal corporate tax rate is fixed, state corporate tax rates vary, making states like Delaware, Wyoming, and Nevada more favorable for incorporation.
Why Is Sales Tax Different in Every State?
Unlike many countries, the U.S. does not have a national VAT (Value-Added Tax). Instead, sales tax is applied at the state and local level, which leads to major differences:
- Rates range from 0% to over 10%, depending on the state and city
- Even within a single state, local jurisdictions may have different rates
- Sales tax usually applies to physical goods, and in some states to digital services
- Essentials like groceries or medicine may be exempt
If you’re selling products online, sales tax nexus is critical. Having a warehouse, office, or employee in a state usually triggers sales tax registration and collection requirements.
Why Foreign Entrepreneurs Need ITIN and EIN Numbers
To operate legally and pay taxes in the U.S. both individuals and businesses need special identification numbers:
- ITIN (Individual Taxpayer Identification Number): Issued to individuals who are not eligible for a Social Security Number but must report U.S. income (e.g., foreign freelancers, landlords, or investors).
→ Freelancers, those with rental income or those working on an E-2/O-1 visa can declare with ITIN.
- EIN (Employer Identification Number): Required for all business entities. It’s used to open U.S. bank accounts, file tax returns, hire employees, and communicate with the IRS.
Marsan Akguc Law Firm assists international clients in applying for ITIN and EIN remotely and securely ensuring full IRS compliance from day one.
Tax Compliance is the Key to Long-Term Success
Understanding the U.S. tax system is vital for anyone doing business or planning to live in the U.S. From income taxes to corporate structures and sales tax obligations, each element plays a role in your financial success and legal compliance.
At Marsan Akguc Law Firm, we offer strategic tax guidance tailored to individuals and businesses navigating the U.S. system.