Governments across the country are always on the lookout for additional sources of revenue to fund their activities and programs. National parks charge an entrance fee, Medicare gets a chunk of your paycheck, imports are assessed customs duties, and the DMV will collect a hefty fee for inspecting your car. The most popular revenue generators, though, are a variety of taxes, like income tax and sales tax. There are even taxes based on other taxes, and these are known as piggyback taxes.
What Are Income Taxes?
Income taxes are collected by various governments based on the overall earnings of an individual or a business.
For the 2020 tax year, the federal government, through the IRS, collected more than $3.5 trillion from gross taxes. In 2021, it collected about $4.05 trillion in revenue. Most of it comes from individual and family income, although corporate income taxes account for a portion as well.
Although simple in concept, the actual calculation of taxes owed can be a complicated affair, as anyone who has filed federal taxes is well aware. Your income is not only salary from a job, but can include many other sources such as interest, dividends, stock sales, lottery winnings and many more. On the other hand, deductions from gross income for the expense of raising children or running a business help to lower your taxable income.
Tax rates vary as well. Federal income tax rates range from 37 percent for high-earners to essentially zero for low-income individuals and families. In fact, some families wind up paying a negative rate of taxes and actually receive money from the government rather than paying into the federal revenue stream.
It's not only Uncle Sam collecting income taxes. Most states assess income taxes as well, as do thousands of local jurisdictions at the county and city level.
Read More: Who Must File Income Taxes?
What Are Piggyback Taxes?
Taxes that are designed as a percentage of other taxes paid are known as piggyback taxes. When taxes are piggybacked off of federal income taxes, they are generally based on the quantity known as Adjusted Gross Income (AGI).
As a simplified hypothetical example, suppose your AGI is $100,000 and you pay federal income taxes of $20,000. Your state may set its income tax rate as two percent of your AGI, in which case you would owe the state $2,000.
Alternatively, it may set its rate as 10 percent of the federal taxes you paid, in which case, you would pay the same amount of $2,000. In other words, the state tax has piggybacked on the federal tax amounts.
A piggyback tax isn't always constructed so simply, however. States may decide to make adjustments to the AGI prior to setting their final tax rate, typically by providing additional opportunities for deductions and exemptions or by voiding some federal exemptions.
Your AGI can increase or decrease as a result before the quantity is used for a calculation of your state income taxes. Similarly, local governments at the county or city level can piggyback on the state amounts or the federal AGI.
States That Piggyback on AGI
Currently, 31 states piggyback on the federal AGI as the basis for computing state income tax. They include The District of Columbia (Washington, D.C.), which also uses AGI in collecting its taxes.
Another six states rely on other federal tax data for state tax calculation, and these too are piggybacking on the federal system.
The remaining states that collect income taxes do so without much of a direct reliance on federal data. Seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming) do not collect income taxes.
Read More: Deducting State & Local Tax on Your Federal Taxes
Some Piggyback Tax Examples
The states that piggyback on AGI are similar in their approaches, in that they set state income tax as a portion of federal AGI.
However, there are some small differences between states. Connecticut and Delaware, for example, automatically update state law as the federal tax code changes. Other states such as Arizona and Hawaii, for instance, have no such provisions for automatic updates, so the calculations in these states can involve differences from the current federal code.
Local governments, likewise, can piggyback on either federally filed income tax or on the state filings. According to the Tax Foundation, 4,964 local jurisdictions, mainly municipalities and counties, impose income taxes. The vast majority of these are piggyback taxes.
Read More: Filing Your Income Tax Return
- IRS.Gov: What is Taxable and Nontaxable Income?
- IRS.Gov: Returns Filed, Taxes Collected & Refunds Issued
- USASpending.Gov: How much money did the federal government collect and spend in 2021?
- IRS.Gov: IRS provides tax inflation adjustments for tax year 2021
- Pewtrusts.Org: How States Piggyback on Federal Personal Income Tax Calculations
- IRS.Gov: Definition of Adjusted Gross Income
- TaxAdmin.Org: STATE PERSONAL INCOME TAXES: FEDERAL STARTING POINTS
- TaxFoundation.Org: Local Income Taxes in 2019
David Sarokin is a well-known Internet specialist with publications in a wide variety of business topics, from the best uses of information technology to the steps for incorporating your business. He is the author of The Corporation, Its History and Future (Cambridge Scholars, 2020) on the role of big business in the modern world, and Missed Information (MIT Press, 2016), detailing how our social systems like health care, finance and government can be improved with better quality information.