Nearly 5,000 different jurisdictions in 17 states have some form of local income taxes. In Ohio, a large number of cities (almost 600) and school districts (almost 200) impose a local income tax, and in Pennsylvania, nearly 3,000 municipalities and school districts combined have some form of local income tax. While this type of tax is more common in the Rust Belt states, all counties in Maryland and Indiana now have a local income tax, as well as some school districts in Michigan and Iowa.
Do you owe local income tax?
Depending on where you are, the tax rates vary, and some taxes change on a regular basis. In fact, some local taxes may be temporary and designed to raise funds for specific purposes, while others are permanent and help fund the city’s operating budget. Some taxes are limited and are either not reported as local income taxes or account for less than 0.01 percent of an employee’s personal income. Most local taxes range from around 1 percent up to around 3.2 percent, but most do not exceed that amount.
How to calculate local income tax
What does that mean for you as the employer? If you work in a jurisdiction in which local income taxes are imposed, you may need to withhold local income tax from your employees’ paychecks. If you are not using payroll software that automatically calculates taxes, you will need to know how to calculate the local income tax due.
- You will first need to figure your employees’ local taxable wages. First, calculate the gross income, or the total amount of money the employee earned before any deductions, taxes, or other withholdings.
- Determine if the employee has any pre-tax deductions, such as Section 125 health insurance or a 401(k) retirement fund. Generally, these costs are deducted before any income tax is figured. Note: Employers may need to contact their local state revenue agency or tax assessor to learn if these pre-tax deductions are taken before figuring local income tax. In some cases, they are not deducted first. For example, in Pennsylvania, employers should first deduct Section 125 health plans from an employee’s gross wages, since they are not subject to any local income tax. However, 401(k) retirement plan contributions are included in local income tax withholdings, so these contributions are deducted after the local income tax is calculated. See our pre-tax vs. post-tax deductions article for more.
- If pre-tax deductions are not subject to local taxes, you should subtract these from the gross wage.
- Using the local tax guidelines available from the local tax assessor’s office, calculate the amount of tax for which the employee is responsible. In some cases, the employee may need to complete and submit a current local tax form showing their city of residence and other tax filing information. You will also need the appropriate tax-withholding table from the city, county, or other area.
- Once you calculate the local income tax, you will withhold the tax from the employee’s pay, along with state and federal income tax.
Companies should set up a separate account to handle local taxes and remit the tax to the local state revenue agency or tax assessor as required (often quarterly, but not always). All companies need to keep detailed records of local taxes collected and filed in case of an audit.
When you complete Forms W-2 for your employees, you will report the employee’s local wages, tips, and other income from which any local, city, or county tax was withheld.
The Small Business Administration’s article about paying taxes lists links to each state’s key websites for additional information about local taxes in your state.
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