How are Payroll Taxes Calculated? – State Income Taxes

State income taxes can be tricky. Check out this quick guide from payroll guru Matt Keller to learn about your state’s requirements.

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Previously, we reviewed how federal income taxes were calculated. State income taxes, with a few exceptions, are calculated very similarly to federal income taxes. But there are some states that have no state income tax at all.

Which States Don’t Have State Income Tax?

There are nine states where you will not see state income tax withholding on your paycheck.  The following seven states have no state income tax:

  • Alaska
  • Florida
  • Nevada
  • South Dakota
  • Texas
  • Washington
  • Wyoming

The following two states impose a limited income tax on individuals, taxing only dividend and interest income, not earned income:

  • New Hampshire
  • Tennessee

Looking for an easier solution to calculating taxes? Check out our digital payroll software platform. 

How are State Income Taxable Wages Calculated?

While one should review the specific rules of their state for unique circumstances, most states generally follow the IRS guidelines for determining taxable wages:

Gross Pay (Including tips and taxable fringe benefits)

  • Less: Section 125 deductions (medical, dental, vision, dependent care, pre-tax commuter benefits, etc.)
  • Less: Deferred income (401k, SIMPLE IRA, 403b, etc.)
  • Equals:  State income taxable wages

Bob is paid semi-monthly. On this paycheck, he earned $8,000 in salary. Bob gets a semi-monthly auto allowance of $1,000. He has a medical deduction of $1,500, and he contributes 10% of his income to his 401k. What’s Bob’s taxable income for state withholding?

*401k is calculated based on the definition of the specific 401k plan. Most plans do not include taxable fringe benefits in the calculation.

Similar to federal income taxes, the income tax withheld for most states is an estimate that uses the marital status of an individual and the number of allowances to determine withholding. Many people use paycheck calculators, such as PaycheckCity, to calculate their state withholding.

Are There Any Exceptions to the Above?

While we can use the IRS method as a guideline, each state has its own set of rules for how they calculate income tax. Highlighted below are some examples of states that calculate income tax differently from the federal guidelines:

Pennsylvania Personal Income Tax – Flat Tax Rate

Pennsylvania does not consider marriage status or withholding allowance for calculating income tax. They use a flat tax rate of 3.07% for personal income tax. The 3.07% rate is multiplied times the earnings to determine the tax. In general, deductions are not taken into consideration.

Health Savings Accounts

Most states follow the federal guidelines for Health Savings Accounts (HSA’s), with the eligible amounts subtracted from earnings before determining state income tax. However, eligible HSA contributions are treated as taxable income for the following three states:

  • Alabama
  • California
  • New Jersey

Arizona Withholding Percentages

In general, Arizona follows the federal guidelines for determining taxable wages, but the state doesn’t use marital status or allowances for determining withholding. Instead, employees complete Form A-4, where they specify a percentage of state income tax to withhold. That percentage is multiplied times the taxable income to determine the withholding. In our example above, if Bob elected a withholding percentage of 2.7%, his state income tax withholding would be calculated as follows:

In general, most states follow the federal guidelines for calculating state income taxable wages, but each state has its own method to determine the withholding on those wages. Once you understand what makes up the taxable wages for state income tax, use of a paycheck calculator such as PaycheckCity can help you confirm the proper withholding amount.

In my next blog, I’m going to review additional employee taxes including state disability and local taxes.

Related blog posts – how to calculate payroll taxes:

Federal Income Taxable Wages

Federal Income Tax Withholding

Social Security and Medicare

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