What Are State Payroll Taxes and Why Must You Pay Them?

Every small business owner with employees must withhold and then pay state payroll taxes. It's just part of doing business that every employer must handle properly. If you don't, you face the likelihood of incurring stiff penalties (late payment fines and interest charges). The purpose of this article is to give you an overview of how the state payroll tax system works, so you can do it right not only the first time, but every time, and thereby avoid any unnecessary expenses.

The types of state payroll tax are somewhat similar to federal payroll taxes. Here are the primary ones that are common to most states:

1. Income tax withholdings. Most states have an income tax. And most states require the employer to withhold state income tax from their employee's paychecks. So you must be sure to properly calculate the appropriate state income tax, withhold that tax from each paycheck, and then send the tax to your state's tax department at the right time, along with the appropriate state income tax withholding form.

Check with your state regarding the timing of these withholding tax payments. The frequency of the payment usually depends on the amount withheld. The more you withhold, the more often you must remit the payment. You may be required to file and pay monthly, quarterly, or annually. It all depends on the numbers.

2. Local income tax withholdings. This also varies from state to state and from locality to locality within the state. By "locality" we are referring to any political subdivision of the state, such as county, city, township, or school district. There's a tremendous variety here across our country, so be sure to check with your local government to find out whether there is a local income tax and what the employer withholding requirement may be.

3. State unemployment tax. Like state income tax, state unemployment tax varies from state to state. This is the tax that is usually paid by the employer to the state for your state's unemployment fund. Typically, every employer must pay a fixed percentage of a certain maximum wage amount for each employee each year. For example, in Indiana an employer starts out with a default state unemployment tax rate of 2.7% of the first $7,000 of wages paid to each employee each year. This 2.7% rate is in effect for the first three years, after which the rate can be adjusted by the state on an employer-by-employer basis, depending on each employer's situation. Many states have an unemployment tax system similar to Indiana, but with perhaps a different tax rate and a different maximum wage amount subject to the tax.