Federal income tax, Social Security, and Medicare contributions are a few mandatory deductions withheld from an employee’s earnings. But as an employer, are you also familiar with state income tax (SIT)? While employees may not be thrilled about it, withholding SIT from your workers’ paychecks often comes with the territory.
What you’ll learn
What you’ll learn
Key takeaways on state income tax (SIT) withholding
- Most states have a tax on wages and other earnings. Businesses withhold state income tax from their employees’ paychecks
- Employers use a worker’s state tax withholding certification to determine how much tax to withhold
- State income tax is a mandatory deduction. Employees can’t opt out of paying it unless they qualify for an exemption
To date, SIT tax applies to 42 states, plus the District of Columbia. States that don’t have an income tax include Alaska, Florida, Wyoming, South Dakota, Tennessee, Nevada, New Hampshire, and Texas. Washington state only has SIT on income from capital gains, not wages.
Each state sets its own rules for taxing income. You’ll find differences in tax rates and filing deadlines, both of which may affect your business. Knowing the basics of SIT tax can help you understand your responsibilities.
What is state income tax (SIT)?
Simply put, state income tax (SIT) is a direct tax levied by individual states on income earned by residents and nonresidents with state-sourced earnings. These taxes are self-assessed, requiring taxpayers to file returns and remit payments, often through employer withholding. Revenue funds essential public services, including education, infrastructure, public safety, and social programs
Do employers pay SIT tax?
Employers don’t pay state income taxes for employees, but they could be subject to business income taxes depending on the state in which they do business,
— Peggy James, CPA
How state income tax withholding works
Businesses generally withhold SIT tax based on their state of residence. So for instance, if you own a company in Kansas, you’ll withhold Kansas state income tax from your employee’s paychecks. However, issues can arise if you have workers who travel across state lines to work for you. In that case, you may need to review state tax reciprocity agreements. These agreements exempt employees from paying taxes in both states.
If there’s no reciprocity agreement and you have out-of-state workers, employees may opt to withhold additional taxes based on their state of residence. Or, they may settle any differences when they file their tax returns.
Determining employee withholding amounts
Most states use withholding forms to help employers calculate their workers’ SIT. These forms are similar to Form W-4, which determines federal income tax withholding. It’s best practice to ask employees to complete their federal and state tax withholding forms when they first join your organization (and many companies make it part of the onboarding process). That way, you can start the withholding process from the employee’s first paycheck.
Exemptions and allowances
Some states have a flat tax, while others follow a progressive system. Under a flat tax, residents pay a set percentage toward income taxes, with fewer credits (if any) allowed. Progressive systems work similarly to the federal tax system, with tax percentages that increase as income increases. They may also offer income tax credits and deductions that can reduce total tax liability.
Employees use their state tax withholding form to certify any allowances or exemptions they may qualify for. For instance, some states offer lower tax rates for taxpayers with dependents. An employee’s tax filing status may also impact withholding rates.
State withholding forms provide instructions on claiming an SIT exemption. If a worker certifies they won’t owe state taxes on the form, you won’t need to withhold SIT from their paycheck. However, they’re responsible for paying any additional income tax liability if it turns out they weren’t exempt.
Employees may also opt to withhold extra money from their paycheck for SIT. It makes sense to do so if they expect a larger tax bill at the end of the year.
Calculating withholding amounts
As a business owner, you’re responsible for withholding SIT from your employees’ paychecks. You’ll use their gross earnings and state income tax withholding form to determine how much to withhold from net pay. Since state tax withholdings can get pretty unwieldy, most businesses use payroll software to prepare employee paychecks. A dedicated payroll platform can simplify calculations and help avoid errors.
Federal vs. state tax withholding
State and federal taxes are two separate withholdings. State taxes go to a state’s taxation department, while federal taxes go to the Internal Revenue Service (IRS). Taxes help pay for public services and programs, such as infrastructure, education, and safety.
You’ll transfer each employee’s federal and state tax withholdings to the appropriate agency. This is usually done on a quarterly basis but some states may follow different timelines. Make sure to send withholdings by the deadline to avoid any penalties or fines.
What is the difference between SUI and SIT?
“SIT refers to state income tax, which is typically withheld from employees’ paychecks but is not considered an employer expense. SUI, on the other hand, stands for state unemployment insurance. It is usually paid only by the employer on behalf of employees, although some states may require employees to pay a portion, too. SUI funds unemployment benefits for eligible workers who receive financial support after a job loss.”
— Peggy James, CPA
Types of withholding
Taxes on employee earnings generally fall into two categories: payroll tax vs. income tax. There are also differences in withholding types and how they’re deducted — pre-tax and post-tax. Here’s a quick breakdown of different withholding types and how they may impact payroll runs.
Mandatory vs. voluntary withholding
Any deduction prescribed by law falls in the “mandatory” category. Examples of mandatory deductions include:
- Federal income tax
- State income tax, for states that have one
- Federal and state unemployment tax (FUTA and SUTA)
- Social Security and Medicare taxes (FICA)
- Wage garnishments
- City or county local income taxes
While these are mandatory withholdings, they may not apply to every business. For instance, if you run a Nevada business with local employees, state income tax doesn’t apply to you. And if your employees don’t have any outstanding garnishments, that isn’t a concern, either.
Voluntary deductions are withholdings your employees opt into. The most common are benefits-related, such as:
- Health insurance
- Disability and life insurance
- Flexible spending accounts
- Retirement plans
Not all employers offer benefits, but if you do, employees may pay to participate. If a worker signs up for benefits, you’ll deduct their contributions from their paycheck. The deduction may be on a pre-tax or after-tax basis. The classification depends on the benefit type as well as federal and state tax rules.
Adjusting withholding for tax credits
Some states offer special tax credits for residents with low incomes or who care for children and dependents. They closely mimic the IRS Earned Income Tax Credit (EITC) and child tax credits, but the guidelines and credit amount may differ. If your state offers a tax credit, the withholding form may include a space for workers to state their eligibility. You’ll use the employee’s certification to apply a reduced withholding amount to their paycheck.
As you can imagine there may be less-than-ideal outcomes for employers who decide to shirk their responsibilities.
Penalties for not paying state income tax (SIT)
If you are curious, state income tax non-compliance typically triggers two types of penalties: failure-to-file and failure-to-pay. Though they vary by state, many follow federal models with some jurisdictional differences. Let’s take a look at an example.
Failure-to-pay penalty
- Fines are usually assessed when taxes owed are not paid by the deadline.
- Federal rate: 0.5% of unpaid taxes monthly, up to 25%. Employers may also be subject to failure to deposit penalties ranging from 2-15% if they don’t deposit payroll taxes according to the required schedule.
- States like Georgia mirror this structure but may adjust rates (e.g., 0.5% monthly with a 25% cap for income tax).
Failure-to-file penalty
- This can result when returns are not submitted by the due date.
- Federal rate: 5% of unpaid taxes monthly, up to 25%.
- Moving from the southeast to the northeast, New York imposes a 5% monthly penalty (capped at 25%) for late filings.
It’s always a good idea to see what resources are available where you do business for more information.
Understanding SIT withholding laws makes good business sense
Calculating SIT tax withholdings is notoriously tricky, even for seasoned accounting professionals. Because of the programs this revenue funds — and the potential for unwanted attention in the form of penalties — employers will want to have a process in place. Businesses looking for an easy way to stay compliant can benefit from payroll software as most handle all the complexities surrounding federal, state, and local taxes out of the box. Best of luck as you keep moving your business forward and our team is ready to help with your questions.
This article is for informational purposes only and should not be relied on for tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors for formal consultation.
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Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.