Companies can ensure they’re adhering to local income tax obligations by keeping these things in mind.
Here's what you need to know:
- Depending on where your employees work or live, they might be subject to local income tax
- As their employer, you’re responsible for withholding all applicable employment taxes from their wages, including any local income tax
- Local income tax is more concentrated in some states than in others
- It’s important to know how to calculate, withhold, remit, and report local income tax
- Payroll software can help you with local income tax
Federal and state employment taxes usually need no introduction. This is because most employers have federal and state employment tax obligations. But there’s another type of employment tax that’s gaining steam. It comes in the form of local income tax.
What is local income tax and who is subject to it?
Local income tax is a type of tax that local governments charge employees who work or live in the jurisdiction. Such local governments include municipalities (e.g., cities and towns), counties, and school districts.
Depending on where your employees work or live, they might be subject to local income tax. This is in addition to whatever federal and state employment taxes they must pay.
As their employer, you’re responsible for withholding all applicable employment taxes from their wages, including any local income tax.
What is local income tax used for?
Local income tax is used to fund local programs, such as:
- Road maintenance
- Education services
- Health services
- Law enforcement services
- Fire services
- Housing services
- Other community programs
Which jurisdictions impose local income tax?
The following states have jurisdictions that charge local income tax on wages:
- New Jersey
- New York
- West Virginia
If your employees work or live in 1 of those states, then you might need to withhold local income tax from their wages. Note that Kansas has a local tax, but it’s for unearned income, such as interest and dividends.
Local income tax is more concentrated in some states than in others. Below are some details from a 2019 report by the Tax Foundation.
|State||Number of Jurisdictions That Have a Local Income Tax|
States like California, Delaware, New Jersey, and Missouri have far lower concentration levels. These states have only 1 or 2 jurisdictions that impose local income tax on wages.
Local income tax rules vary by jurisdiction
Key considerations for employers:
- Who must pay local income tax? Is it employees who live in the locality, employees who work in the locality, or both groups?
- What is the specific name of the local income tax? This differs by jurisdiction. For instance, there’s Ohio school district tax, New York City income tax, and Portland Metro Supportive Housing Services (SHS) Income Tax.
- How many types of local income taxes apply to your employees? For example, Pennsylvania has 2 types of local income taxes: Earned Income Tax (EIT) and Local Services Tax (LST).
- Is the local income tax temporary or permanent? The locality may impose a short-term local income tax on employees to fund certain projects, such as bridge or road repairs.
There’s also the question of how to calculate, withhold, remit, and report local income tax. We cover these next.
How is local income tax calculated?
This varies by locality. That said, local income tax is typically based on either of the following:
- A flat percentage (e.g., 1% or 2% of taxable wages)
- A tax rate that goes up as the employee’s pay increases
- A fixed dollar amount, regardless of how much the employee earns
Different tax withholding rates may apply to residents and nonresidents.
How do employers withhold local income tax?
To withhold state income tax, you must register your business with the state taxation agency. If you must also withhold local income tax, then you may or may not need to register with the local taxation agency as well. For example, employers in Ohio need to register only once with the Ohio Department of Taxation for both state income tax and school district tax withholding.
Keep in mind that not all wages are subject to local income tax.
In addition, you may need to give new hires a local income tax withholding form (comparable to Form W-4) to complete. There might be other local withholding forms as well. For example, Pennsylvania has a Residency Certification Form that employers must fill out.
If your employees are subject to local income tax, withhold it from their wages based on the mandated withholding tax rate.
Keep in mind that not all wages are subject to local income tax. For example, some localities exclude payments for Section 125 health insurance from local income tax.
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How to remit local income tax
Typically, employers remit their employees’ local income tax withholdings to the local taxation agency, by the required deadline. This is separate from remitting state income tax withholdings to the state taxation agency.
However, in some jurisdictions, employers remit both state and local income tax withholdings to the state taxation agency. It all depends on the jurisdiction’s rules.
How to report local income tax
If you withheld local income tax from your employees’ wages, you must report it on their annual Form W-2 as follows:
- Box 18, the amount of local wages subject to local income tax
- The amount of local income tax withheld, Box 19
- Box 20, the name of the locality
File the W-2 form with the required local taxation agency. You may also need to perform other forms of local reporting, such as wage and tax reporting.
If you do not know which local agency oversees local income tax in the area, contact the state taxation agency. They can direct you to the right place. Remember, in some cases (like Ohio), the state taxation agency administers state and local income taxes.
Local income tax can get complicated
It’s not always easy to understand local income tax laws because there are many nuances involved. Things can get complicated if you have employees who work in different localities. Moreover, a few localities impose local payroll taxes on employers who do business in the jurisdiction.
Payroll software can help you with local income tax
Here’s how payroll software takes the pain out of local income tax administration:
- Calculates local income tax based on where your employees live or work
- Takes the employee’s resident or nonresident status into account
- Determines local income tax based on the jurisdiction’s definition of “taxable wages”
- Factors in any state reciprocal tax agreements that might be involved
- Computes applicable employer local payroll taxes
- Allows you to remit and report local income tax electronically
- Provides a centralized database for local income tax record keeping
- Keeps you updated on changes in local income tax laws
More and more localities are enacting local income tax laws. Even if you don’t have local income tax obligations, that could change, so keep an eye out for new developments.