State Income Tax: How It’s Calculated, and Who You Owe

August 22, 2019

State Income Tax withholding is an important component of an employee's paycheck. See how you should calculate SIT for employees, and which states to pay.

State Income Tax Cover Image 1
Photo by Alan Cleaver | Source: | CC by

State Income Tax is the driving force behind many people’s decisions on where to live. I live in the state of Tennessee, so if I’ve heard it once I’ve heard it a million times. “I moved here because I don’t have to pay State Income Tax!”

Now, calculating State Income Tax isn’t particularly complex. However, there are some aspects of the calculation that are unique to certain states. Therefore, it is important to know the details of this tax.

Tricky SIT

Besides knowing calculations for one state, what happens when you employ someone who lives in one state but works in another? Or, if you have a worker who has homes in more than one state? If either of these scenarios fits your situation, then this is the post for you.

So, continue reading to find out more about State Income Tax. This information may be for you if your state has any special income tax details. Also, this will be helpful if you have an employee with a complex residency circumstance.

What Is State Income Tax?

By now, you have likely realized there are all kinds of taxes coming out of your employees’ paychecks. For instance, the largest amount is probably for Federal Income Tax, or FIT. Next, you should see FICA coming out, which is Medicare and social security combined. Furthermore, you may see other deductions, but those are items such as benefits or garnishments.

Now, for clarification on the State Income Tax, or SIT. This is the tax that is withheld to help fund programs in each state. Thus, funds collected through SIT would apply to the well being of the people in that state. In other words, those funds could help create a program or make improvements within the state. Conversely, FIT taxes apply to federal programs.

States Without Income Tax

Presently, there are nine states that don’t have a true State Income Tax. So, if your business is in one of the following states, you will not withhold State Income Tax.

  • Alaska
  • Florida
  • Nevada
  • New Hampshire
  • South Dakota
  • Tennessee
  • Texas
  • Washington
  • Wyoming

Keep in mind, this rule applies as long as your employees also have a permanent residence in those states.

States With State Income Tax

Now, if you are reading this, there is a good chance your business is in a state that collects State Income Tax. Or, perhaps you are employing someone who lives in a state that collects SIT. If that is the case, then there is more information you will want to know.

First, State Income Tax is not necessarily a straight percentage. In other words, you can’t just take a percentage of the employee’s gross income. However, you will start by determining a worker’s gross income. Then, you must consider deductions and exemptions to determine SIT taxability. Finally, you will use the state income brackets for each state to determine the amount to collect.

Related:  Why It's Important to Take Your Vacation Days

Sky-High SIT

Notably, there are several states with fairly high State Income Tax percentages. The SIT tax in theses states rival the withholding percentage of the FIT tax. These states range from Wisconsin at 7.65% to California at 13.3% in 2018. The other states that fall between Wisconsin and California are:

Photo of Iowa Department of Revenue state income tax forms, a calculator, and a pen.
Photo by Christine Yanner
  • New York
  • District of Columbia
  • Vermont
  • New Jersey
  • Iowa
  • Minnesota
  • Oregon
  • Hawaii

So, if your business is in one of these states, you should be withholding SIT from employees.

Straight Shooters SIT States

Additionally, there are eight states that don’t have multiple brackets for State Income Tax. This makes calculating SIT a little less complex. States with one tax bracket include the following:

  • Colorado
  • Illinois
  • Indiana
  • Massachusetts
  • Michigan
  • North Carolina
  • Pennsylvania
  • Utah

While you might find it shocking that these states have such high State Income Tax rates, there is good news. Specifically, the State Income Tax is deductible in some cases. In particular, when itemizing the Federal Income Tax Return. In this case, SIT might be deductible.

The Employer’s Responsibility

Now, for the sticky tax situations. What happens when the employee lives in a different state than the business location? Or, what happens if the employee resides in multiple states?

Well, the American Payroll Association says this is a multi-state taxation compliance issue. In other words, it’s serious. The reason this is tricky is that sometimes it’s like splitting hairs. It can be difficult to determine if an employee works or performs services in another state.

So, what should you do? Well, let’s take the words straight from the horse’s mouth. According to the APA, you will start where the employee lives and works. This means the employer is responsible for determining the employee’s state of residency. The APA recommends defaulting to one rule as a starting point. First, you will determine the state of residency. If the state of residency is the same as the state where the employee works, then SIT is withheld and paid to that state. Of course, if the state does not collect State Income Tax, then no SIT will be withheld from the employee.

Blurred Lines

Now, let’s consider if an employee performs work outside the state of residency. So, if an employee works outside the state of residency, it gets a little more complicated. First, the employer will need to check to see if the two states have a reciprocal agreement. This means for tax purposes, the states agree that SIT will only be withheld for the state of residency.

Related:  Your Guide to Pre-Tax Deduction Dollars

However, if a reciprocal agreement is not in place, then the employer must withhold State Income Tax for all states associated with that employee.  The withholding calculation is according to each state’s unique specifications, in conjunction with the amount earned in that state.

Not So Fast

Now, if this information tempts you to jump ship and move to a SIT-free state, you might want to sleep on it. First, I’m going to advise against it for my home state. Tennessee can’t currently support a bigger influx of transplants than we already have. However, that is selfish on my part, so I’ll tell you why moving might not be great for you.

The downside of not withholding State Income Tax is those states have to get funds elsewhere. In Tennessee, for example, residents pay a high sales tax. So, a higher sales tax helps offset the lack of State Income Tax.  The 2019 sales tax rate in Tennessee is 7%, combined with our county rate of 2.25%.  The total sales tax rate where I live is 9.25%. While this might not seem like a big deal if you are buying a pair of socks, you will feel the pinch when you buy a car. Consequently, if you are a high-volume consumer, you could end up paying more in sales tax than you do in SIT.

Stating the SIT Facts

State Income Tax is something that affects the majority of U.S. citizens. However, it is not always a complicated tax, and it is also deductible in some cases. Moreover, living in a state that withholds income tax might save you from a high sales tax rate. Either way, it is the employer’s responsibility to know how to calculate State Income Tax. Additionally, the employer needs to know which employees owe tax to more than one state. So, I recommend staying on top of information regarding State Income Tax. When in doubt, rest assured your dedicated payroll provider will update you with the most current SIT information.

Subscribe to our newsletter

Get the latest from the world of payroll & HR delivered straight to your inbox!