An HR Glossary for HR Terms
Glossary of Human Resources Management and Employee Benefit Terms
State Withholding Tax
What Is State Withholding Tax?
State withholding tax refers to the deductions that employers make from an employee's paycheck for state income taxes. Each state has its own tax rates and procedures. It’s similar to federal income tax withholding (FITW), but the amount you pay depends on each state’s unique tax structure. Your employees’ earnings (wages, tips, commissions, etc.) may be subject to the following:
- Flat income tax: Some states have a single-rate, flat tax levy that applies to all employees no matter how much they earn.
- Graduated-rate income tax: Most states collect graduated-rate income taxes that progressively increase as employees enter higher income tax brackets.
A handful of states are income-tax free, which means employers don’t have to deduct state withholding tax when they run payroll (exceptions may apply for remote workers).
State Taxes vs. Local Taxes
Some towns, cities, and counties impose local income tax levies, or municipal taxes, to fund community programs. Just like state taxes, the withholding amount varies by location. Knowing if your employees’ earnings are subject to local income taxes is an additional part of the payroll process.
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State Withholding Forms
Every US employee fills out a federal W-4 form from the IRS when they start a new job. But in areas with income tax, they generally also need to complete a separate state withholding form, or state W-4.
For example, NYS employees must complete Form IT-2104 and California uses Form DE 4. Giving employers vital information about their tax responsibilities at the state level, these forms provide insights into the employee’s:
- Filing status (e.g. single/head of household, married)
- Withholding allowances
How to Calculate State Withholding Tax from Your Paycheck
The amount of money employees pay in state taxes depends on how much they earn, the income tax rate, and other factors. Here’s a general overview of how to calculate state withholding tax:
- Compute the employee’s gross pay for the current pay period.
- Subtract voluntary pre-tax contributions (e.g. 401(k), health insurance).
- Using your state’s tax guide, deduct the appropriate percentage from the newly adjusted total.
With some exceptions, state withholding tax filing deadlines typically coincide with federal due dates. Refer to state government regulations for the most current information.
Example: How to Calculate California State Tax Withholding
California is a state with graduated-rate income taxes, so you’ll need to take the employee’s tax bracket into account. In this state, there are two ways to calculate withholding for personal income tax:
Method A: Wage Bracket Table
Designed for employees making less than $1 million, the wage bracket table method lets you identify the appropriate tax withholding amount based on the employee’s filing status, number of withholding allowances (if applicable), and payroll period:
- Step 1: Figure out your employee’s gross wages and compare them to California’s Low Income Exemption Table.
If they’re less than or equal to the amount in the table, withholding state income tax isn’t required. If they aren’t, continue to Step 2.
- Step 2: Subtract any additional withholding allowances for deductions from the employee’s gross wages using the amount shown in the Estimated Deduction Table.
- Step 3: Subtract the number of additional withholding allowances from the total allowances to obtain the employee’s net allowances.
- Step 4: Find the state tax withholding on the appropriate state wage bracket table.
Method B: Exact Calculation
The exact calculation method takes payroll period, filing status, number of withholding allowances, standard deduction, and exemption allowance credits into account. Using this method, you can calculate state tax withholding for your employees manually or by computer:
- Step 1: Repeat Step 1 from Method A.
- Step 2: See if additional withholding allowances for estimated deductions are indicated on the employee’s DE 4 form, and subtract the amount shown in the Estimated Deduction Table from their gross pay.
- Step 3: Subtract the standard deduction amount shown in the Standard Deduction Table to obtain the employee’s taxable income.
- Step 4: Using the employee’s payroll period and marital status as a guide, find the applicable line on the Tax Rate Table for their taxable income and perform the tax-liability calculation as specified.
- Step 5: Subtract the tax credit shown on the Exemption Allowance Table from the tax liability to figure out the amount of tax you should withhold from their paycheck.
What States Do Not Have State Income Tax?
Employers and employees in certain areas don’t have to worry about this levy. As of 2023, the list of states without state income tax includes:
- New Hampshire*
- South Dakota
*Washington and New Hampshire don’t have traditional state withholding tax, but other income levies apply. Washington taxes capital gains of some high earners, and New Hampshire taxes dividends and interest income.
State Income Tax Rules for Remote Workers
As of 2023, it looks like remote work is here to stay. This means more employers must figure out how to handle increasingly complex state payroll taxes for their workforces. Depending on where your remote workers live, this could play out in several ways:
- Employees live and work in the same state as the company: If your remote workforce lives in your state, you probably only need to pay your own state’s income taxes (if it has any).
- Employees live and work in a different state than the company: In this scenario, you’ll likely pay taxes for the employee’s state.
- Employees live in the same state as the company, but work in another state: In this case, you’ll likely pay the taxes for your company’s home state.
Also, state-specific tax rules can influence payroll. For instance, a handful of states abide by the convenience of the employer rule, which allows them to tax nonresident employees based on the company’s location. Convenience rule states with an official policy include:
- New York
- New Jersey
Other factors to consider include state reciprocity and reverse tax credits. Many neighboring states share reciprocity agreements, which free nonresidents from withholding. The reverse tax credit system requires taxpayers to file in both states but helps avoid double taxation.
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