Unless you live in one of the nine U.S. states with no state income tax, you’ll pay both federal and state income tax on your earnings. If you’re on a company’s payroll, your employer will withhold that tax from each paycheck to make sure you don’t owe at tax time. If you’re self-employed or you run your own business, though, you’ll need to take care of federal and state withholdings yourself.
What Are State Withholdings?
In order to pay for services to the public, federal and state governments tax the earnings of residents. These taxes are withheld from employee paychecks and, at the end of the year, taxpayers report what they’ve paid to both the IRS and their own state’s department of revenue. If you paid too much in throughout the year, you’ll get a refund. If you paid too little, you’ll owe the difference and, in some cases, penalties for underpaying.
On a federal level, you may be required to pay penalties if you owe more than $1,000 after subtracting all of your withholding and refundable credits. If your withholding was at least 90 percent of the tax for that year or 100 percent of the tax you owed in the previous year, your penalty will be waived.
Impact of Location
The rules regarding withholding taxes on a local level vary by jurisdiction. Seven states don’t have income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. So if you live in one of those states, you won’t have to worry about state withholdings, but you’ll still see federal taxes withheld from your paycheck.
Two more states, New Hampshire and Tennessee, don't tax regular income either, but they do tax investment income. However, each state has its own laws as to whether a person qualifies as a resident of a state for tax purposes. If you own a second home in Florida, for instance, you’ll need to spend more than half the year in that state to take advantage of that state’s lack of an income tax.
Read More: Which States Do Not Charge State Income Taxes?
Understanding Tax Withholdings
When you receive a paycheck, you likely notice that your net earnings are noticeably less than your gross earnings. Gross earnings refer to the amount you make before any deductions are taken out, while net earnings are the funds you see deposited in your bank account on payday. A variety of things can come out of your gross earnings, including any money you put toward your health insurance benefits. But you’ll likely notice the bulk of those deductions goes to taxes.
You may not realize it, but you direct your employer on how much to take out of each paycheck and submit to the government on your behalf. Form W-4 tells employers how much to withhold from each paycheck, based on your marital situation and your number of dependents.
But there’s separate paperwork you’ll fill out for withholding your state income tax. Although you complete these forms when you start a new job, you can update them at any time, so it’s important to revisit them as your circumstances change.
State Withholdings for Payrolled Employees
The state withholding tax definition generally addresses employees who work on a payroll versus those who work as independent contractors. Payroll-based employees don’t have to pay much attention to how income taxes are withheld since it’s all handled for them. Whether you’re paid hourly or are on salary, all you need to do is check to make sure you’re having enough taken out, both on a federal and local level, and adjust next year if you find the amounts are off.
If you live in one of the states where income tax is collected, you’ll see the withholdings on your pay stub along with your federal income tax withholdings amount. It may be listed as SIT or SITW, for “state income tax” or “state income tax withholding.”
If you move from a state that doesn’t collect income tax to one that does, or vice versa, you’ll need to make sure you’re having taxes withheld on your paycheck, especially if you work for a business that has employees across multiple states. If you forget, you may get an unpleasant surprise at tax time.
Read More: State Tax Vs Federal Tax
State Withholdings for Self-Employed
If you’re self-employed, paying taxes is on you. The IRS expects you to pay taxes quarterly if you expect to owe $1,000 or more when you file in April. Generally, you’ll shoot for paying one-fourth of what you’ll owe in April each quarter, but if your income fluctuates, this can be difficult to predict. Things get even more complicated if you live in one of the many states that have a state income tax since you’ll have an obligation to pay those as you go as well.
As with federal taxes, you’ll be expected to pay quarterly if you expect to owe more than a certain amount at tax time. In California, that amount is $500 or $250 if you’re married filing separately. In many states, though, you’re simply required to pay at least 90 percent of this year’s tax liability or 100 percent of last year’s tax liability in advance or risk penalties.
Multiple State Withholdings
Unfortunately, some taxpayers find it isn’t as simple as having taxes withheld in one state. If an employee lives in one state but performs work in another, for instance, an employer has to look to the law to determine how to withhold that employee’s state income taxes. The general rule is that the employer should base taxes on the state where services were performed. But if the employee lives in one state and works in another, businesses are directed to apply three rules to determine how to tax the employee:
- In some instances, an employee who holds residency in a state but performs work in another may be required to pay taxes in the state of residency if the business has operations in that state.
- If an employee lives in one state and works in another, both states’ laws of reciprocity need to be considered.
- If an employee lives in one state and works in another, employers must also consider both states’ resident/nonresident taxation practices.
It’s important to make sure you’re having the right amount withheld for the state you live in, especially if you’ve relocated from one state to another at some point after setting up your withholdings. Even if your employer has employees in both states, you may find that your withholdings aren’t adjusted unless you check in on them.
One benefit to withholding tax for state and local purpose is that you can deduct them on your federal taxes.
City Income Tax Withholdings
In addition to federal and state withholdings, some workers are subject to local income tax. These are generally nominal amounts, so it won’t cut into your earnings drastically. If you live in Ohio or Pennsylvania, chances are you’ll owe local tax, since many cities in these two states levy a tax on local workers. But those living in Colorado will only need to worry about local income tax if they live in Aurora, Denver or Glendale since those are the only three cities that impose it.
You may also see the local income tax listed in other ways. In Colorado, for instance, local income tax is called Occupational Privilege Tax. Pennsylvania calls it the Earned Income Tax, and tacks on a Local Services Tax that all employees in eligible areas must pay. The Earned Income Tax is only assessed on wages that are earned, so it won’t affect unearned income such as disability or retirement funds.
Since state and local tax withholdings can vary so dramatically, it’s important to make sure you study the laws specific to your area and make sure you’re having enough withheld throughout the year.
Filing State and Local Taxes
In most states, taxpayers have a little extra work after they’ve zipped their tax return off to the IRS. The next step is to file your state income taxes. If you use tax preparation software or an accounting professional, you’ll likely input this information as part of preparing your federal taxes. If you are handling the whole thing manually, though, you’ll need to gather separate forms to file any local or state income taxes you need to remit.
Although you can file each of your returns separately, there are benefits to using an e-filing system that submits your federal, state and local taxes in one go. When you submit that way, you’ll find all of your tax returns are linked, making it easier to track their status.
For verification purposes, many states now look for that confirmation that the IRS has received and approved a taxpayer’s federal return before putting the local returns through. This gives state and city revenue departments additional fraud protection. Without having your returns linked, you may find there’s a slowdown in processing time.
Deducting State and Local Taxes
One benefit to withholding tax for state and local purpose is that you can deduct them on your federal taxes. Known as the SALT deduction, this benefit lets taxpayers deduct the taxes they pay on a state or local basis. Taxpayers in states with an income tax can choose between deducting their state and local income tax or sales tax, but they must itemize to do so. Since the standard deduction has increased to $12,400 per taxpayer in 2020, even fewer taxpayers are likely to go for this deduction.
The Tax Cuts and Jobs Act changed that slightly, though. There’s now a cap of $10,000 per return on state and local tax deductions. Experts say that the SALT deduction has largely been used by high-dollar earners, but it is by far the most popular deduction among those who itemize.
In fact, of the one-third of taxpayers who itemize, nearly all of them take the SALT deduction. Since SALT also includes property taxes, the loss may be felt by those who counted on those deductions to reduce their tax liability each year.
Read More: Deducting State & Local Tax on Your Federal Taxes
State Income Tax for Employers
Employers have an entirely different perspective on state income tax withholdings. If you’re an employer, you’re required to find out what your obligation is to withhold taxes on the workers you hire and make sure you meet those responsibilities. This means visiting your local department of revenue online and researching what income is subject to tax.
Your state and local authorities should also be able to provide a copy of the withholding tables you can use to determine how much you should take out of each paycheck. You’ll also need to determine exactly how you’ll submit your employee’s taxes and follow through on making sure the funds are remitted on time.
Just as your business is required to file information returns to document the payments you’ve made throughout the year, you may be required to file similar reports to track the state income tax you paid. Research your responsibilities in this area to make sure you’re collecting the information you need to have throughout the year. Even if you aren’t required to file an information return, good documentation can help protect you in the event of an audit down the line.
- Bankrate: Is a state with no income tax better or worse?
- IRS: Topic Number 306 - Penalty for Underpayment of Estimated Tax
- Kiplinger: How to Claim Florida as Your State of Residence to Save on Taxes
- IRS: Estimated Taxes
- Credit Karma: 5 things you should know about filing state income taxes
- IRS: Am I Required to File a Form 1099 or Other Information Return?
- Business Insider: There are 9 US states with no income tax, but 2 of them still tax investment earnings
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.