Most employee wages are subject to two types of income tax withholding: federal income tax and state income tax. While federal income tax applies to all employees and the same rules apply nationwide, state income tax is different. State income tax has a unique setup in every state.
What is state income tax?
Most states have state income taxes. If you employ workers in a state with income taxes, you will subtract state income taxes from their pay before you give them their final paychecks. States use income taxes to fund a variety of state projects and programs, including education, Medicaid and health care, corrections, and public assistance.
How much is state income tax?
State income tax rates vary. States decide their own rates.
Some states have single-rate tax structures, meaning one flat tax rate applies to all employees of all pay levels. Other states have graduated-rate tax structures, meaning they have tax brackets with different tax rates for multiple income levels.
With federal income taxes, employees can claim withholding exemptions that reduce the amount of tax withheld from their income. Some states allow withholding exemptions, too. The exemptions might be tied to federal exemptions, or states might set their own exemptions. Some states don’t allow exemptions from state income tax withholding.
In the end, you should reference your state tax code to learn how much to withhold from employee paychecks.
Income tax by state
Let’s take a look at states without state income tax on employment income. Then, let’s look at states with income taxes on employment income.
States with no income tax
There are seven states without income tax.
- South Dakota
Two states have income tax only on dividend and interest income. These states do not have any income taxes on employment income.
- New Hampshire
States with state income tax
Forty-one states and Washington D.C. have income tax on wages earned from employment.
|Indiana||New Jersey||Washington D.C.|
|Iowa||New Mexico||West Virginia|
Remember, you should check the income tax regulations for your state. Each state has its own income tax rules and rates.
State income tax map
State tax reciprocity
You might have an employee who lives in one state but works in another. For example, you have an employee who lives in Ohio but travels to your business in West Virginia to work. How do you handle taxes for this employee?
Typically, you will withhold taxes for the state the employee works in. The employee would still owe taxes for the state they live in. But if the work state and home state have a tax reciprocity agreement, the employee can become exempt from taxes in the work state. You then withhold taxes for the employee’s home state.
The employee must notify you of the reciprocal tax agreement by filling out a tax exemption form from their work state. Once you receive the form, you must stop withholding for the work state and begin withholding for the home state.
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This article is updated from its original publication date of 1/28/2015.