What Is State Tax Withholding and How Does It Work?

State tax withholding is the system employers use to deduct a portion of an employee’s wages for payment to the state tax authority. This process is not an additional tax, but a method of prepaying your anticipated state income tax liability throughout the year. By remitting a part of your owed taxes from each paycheck, the system aims to reduce the likelihood of a large tax bill when you file your annual state tax return.

Factors That Determine Your Withholding Amount

The amount of state income tax your employer withholds is determined by the information you provide on a state-specific withholding certificate. Most states with an income tax have their own version of this form, which functions similarly to the federal Form W-4. The information you supply, such as your filing status, directly influences the calculation as it corresponds to different tax brackets and standard deduction amounts.

Another factor is the number of withholding allowances or exemptions you claim. While the federal W-4 was revised to remove allowances, many state forms still use them to account for dependents and other tax credits. Claiming more allowances reduces the amount of tax withheld, while claiming fewer increases it. You can also request that your employer withhold an additional flat-dollar amount from each check if you have other income not subject to withholding.

Your employer uses the details from your completed state withholding form, along with state-provided tax tables or formulas, to calculate the amount to deduct. These calculations convert your annual allowances and filing status into a specific dollar amount to be subtracted from your gross pay each pay period.

How to Adjust Your State Tax Withholding

To change the amount of state tax withheld, you must obtain the correct state withholding allowance certificate from your employer’s human resources or payroll department. This form is often available through an online employee portal. You must complete this form with updated information, such as a new filing status, a different number of allowances, or a new additional withholding amount.

After filling out and signing the new withholding certificate, submit it to your employer. Companies have procedures for this, which may involve uploading the document to an internal system or providing a physical copy to the payroll administrator.

After submission, the adjustment to your withholding takes effect within one to two pay cycles, depending on your employer’s payroll schedule. You can verify the change has been implemented by reviewing the state tax deduction on your subsequent pay stubs.

Withholding for Multi-State and Remote Workers

State tax withholding is more complex for individuals who live in one state and work in another. Income is subject to tax in the state where the work is physically performed, which for remote workers is their home state. This can create a situation where an employee is liable for taxes in both their state of residence and employment.

To prevent double taxation, states use mechanisms like reciprocity agreements. A reciprocity agreement is a pact between two states that allows a resident of one to be exempt from the income tax of the other. If an agreement exists, you can file an exemption certificate with your employer, who will then only withhold taxes for your state of residence, simplifying your tax filing.

If no reciprocity agreement is in place, your home state provides a tax credit for taxes paid to the work state. Your employer will withhold taxes for the work state, but you can claim a credit for that amount on your resident state tax return. This credit is limited to the amount of tax your home state would have charged on that same income, preventing double taxation.

Impact of Withholding on Your Tax Return

The total amount of state tax withheld throughout the year directly affects the outcome of your annual tax return. The Form W-2 provided by your employer shows the total state tax you have already paid for the year.

If the total amount withheld exceeds your actual state tax liability, you will receive a tax refund. Conversely, if your total withholding is less than what you owe, you will have a balance due that must be paid when you file your return.

Withholding significantly less than your tax liability can lead to an underpayment penalty, which is calculated as a percentage of the underpaid amount. To avoid a penalty, you must pay at least 90% of your current year’s tax liability or 100% of your previous year’s tax liability. For those with higher incomes, the prior-year requirement is often increased to 110%. Some states use different standards, such as assessing a penalty only if you owe more than a certain amount, like $1,000.