Every small business owner comes up against the question sooner or later: how do you calculate state tax? After all, these taxes affect your business and all your employees, and if you do business in different states, there are different laws to remember. 

Each state has its own tax system, which means the rules and rates can vary widely. Knowing the basics will give you a clearer picture of what to expect.

Let’s break down what state taxes are and look at some common examples.

What is state tax?

State tax is a tax levied by individual states. Each state sets its own tax rates and rules, which means the amount you pay can vary depending on where you live or work. The revenue generated from state taxes funds state budgets and services, such as education, healthcare, and infrastructure projects. 

What types of state taxes are there? 

Feeling overwhelmed by the different types of state taxes? You’re not alone. Many people find it confusing to figure out how to calculate state tax when you have to navigate state income, sales, and property taxes, especially with varying rules and rates. 

Here’s a quick breakdown of each:

State income tax.

State income tax applies to the income you earn, whether you’re a resident or a non-resident working within the state. Each state sets its own rates and brackets, which means the amount you owe can vary. Some states have a flat tax rate, while others use a progressive system where the rate increases with higher income levels. 

To calculate your state income tax accurately, you need to report all sources of income, including wages, salaries, and investment earnings. Knowing how to calculate state income tax involves payroll taxes, so small business owners need to keep them in mind with every payroll run and transaction. 

State sales tax.

State sales tax is imposed on the sale of goods and services within the state. When you buy items like clothing, electronics, or dining out, you pay a percentage of the purchase price as sales tax. The rate can differ from state to state, and some states may exempt necessities like groceries or prescription medications. 

Retailers collect this tax at the point of sale and remit it to the state. If you run a retail business, understanding state sales tax is a must. 

State property tax.

State property tax is based on the value of real estate and personal property you own within the state. This tax funds local services such as schools, police, and fire departments. 

Property tax rates and assessment methods can vary, but they generally depend on the property’s market value. You receive a property tax bill from your local government, which outlines the amount due and the payment deadline. Keeping track of property assessments and understanding how your tax is calculated can help you manage these expenses effectively.

How state taxes work.

How are state taxes calculated? State governments determine the tax rates and rules for different types of taxes, which can vary significantly from one state to another. For example, some states have higher income tax rates, while others may have no income tax at all. The rules also dictate what income or purchases are taxable and what exemptions or deductions are available.

State taxes are collected from different sources depending on the tax. Here’s an overview of how each type of state tax is collected:

State tax collection through employers. 

 Employers play a role in state income tax collection by withholding the appropriate amount from an employee’s paycheck. This process ensures that employees’ state income tax obligations are met throughout the year, reducing the likelihood of a large tax bill when filing a state tax return. 

The amount withheld depends on the employee’s income, filing status, and any additional withholding allowances they claim. To have a full picture of withholdings, small business owners and employees should also understand the federal income tax system.

State tax collection through businesses.

Businesses are responsible for collecting state sales tax on goods and services sold within the state. When a customer makes a purchase, the business adds the sales tax to the total price and collects it at the point of sale. The business then remits the collected sales tax to the state government. This system ensures that sales tax revenue is collected efficiently and accurately.

State tax collection from property owners. 

Property owners pay state property tax based on the assessed value of their real estate and personal property. Local governments typically handle property tax collection, using the revenue to fund essential services like schools, police, and fire departments. 

Property tax rates and assessment methods can vary, but they generally reflect the property’s market value. Property owners receive a tax bill outlining the amount due and the payment deadline.

How to calculate state income tax. 

So how is state income tax calculated? It can seem daunting at first, but going step-by-step will help you calculate state tax manageably. 

1. Determine taxable income. 

To calculate your state income tax, start by determining your taxable income. Begin with your gross income, which includes all earnings such as wages, salaries, bonuses, and any other income sources. This figure represents your total income before any deductions or exemptions.

Next, subtract any deductions and exemptions to arrive at your taxable income. Deductions can include items like student loan interest, retirement contributions, and certain medical expenses. 

Exemptions typically include personal exemptions for yourself and dependents. Each state has its own rules for what qualifies as a deduction or exemption, so make sure to check your state’s guidelines through your state website. 

2. Apply state tax rate. 

Once you have your taxable income, the next step is to apply the state tax rate. Find the appropriate rate for your taxable income bracket within your state. Multiply your taxable income by this rate to calculate the amount of state income tax you owe. 

For example, if your taxable income is $50,000 and your state tax rate is 5%, you would owe $2,500 in state income tax.

3. Adjust for credits.

After calculating the initial tax amount, adjust for any available state tax credits. Tax credits directly reduce the amount of tax you owe, unlike deductions, which reduce your taxable income. 

Common state tax credits include those for education expenses, energy-efficient home improvements, and child care costs. Check your state’s tax agency website for a list of available credits and their eligibility requirements.

4. Factor in additional rules.

In addition to credits, account for reciprocity agreements between states. Reciprocity agreements allow residents of one state to work in another state without being subject to double taxation. If you live in one state and work in another, you may only need to pay income tax to your state of residence. Verify if your state has such agreements and how they apply to your situation.

Finally, consider any other factors that might affect your state income tax calculation. These can include local taxes, additional deductions, or special tax rules for certain types of income. Make sure to review your state’s tax guidelines thoroughly to ensure accurate calculations.

By following these steps, you can calculate your state income tax accurately and ensure compliance with state tax laws.

5 tips for managing state taxes.

Managing state taxes can be a challenge, but with the right strategies, you can stay on top of your obligations and even save some money. Remember these tips next time you’re calculating state taxes for your small business or personal income: 

1. Know your state’s tax laws.

Understanding your state’s tax laws helps you stay compliant and avoid unnecessary penalties. Each state has its own tax rates and rules, which can change annually. Regularly check your state’s tax agency website for updates on tax rates, deductions, and credits.

You should also familiarize yourself with the types of income that are taxable and any exemptions that may apply to you. This knowledge allows you to plan your finances better and ensure you are not overpaying or underpaying your state taxes.

2. Keep accurate records.

Maintaining accurate records is vital for managing your state taxes effectively. Track all sources of income, including wages, freelance work, and investment earnings. Keep detailed records of any deductions and credits you plan to claim, such as charitable donations, medical expenses, and education costs. 

Organized records make it easier to prepare your state tax return and provide documentation if you are audited. Use digital means to store and categorize your financial documents, ensuring they are easily accessible when needed. Better yet, use digital tools or apps like Homebase payroll to automatically calculate and withhold the correct taxes based on local laws. 

3. Withhold the right amount.

As a small business owner, ensuring the correct amount of state tax is withheld from your employees’ paychecks helps them avoid a large tax bill or a hefty refund at the end of the year. Use state withholding calculators to determine the appropriate amount to withhold based on their income, filing status, and any additional allowances. 

Employees should adjust their withholding if they experience significant changes in financial situation, such as a new job, a raise, or a change in marital status. Regularly reviewing and updating withholding helps both employers and employees stay on track with tax obligations.

For hourly teams that work in an environment with tipping, taxes need to be reported on tips too. Make sure you track, report, and withhold tax on tips accurately for your small business. 

4. File state returns on time.

Filing your state tax returns on time prevents late fees and penalties. Be aware of your state’s filing deadlines, which may differ from federal deadlines. Mark these dates on your calendar and set reminders to ensure you complete and submit your return on time.

If you need more time to prepare your return, check if your state offers an extension and understand the process for requesting one. Filing on time also ensures you receive any refunds you are owed promptly.

5. Consult a tax professional.

For complex tax situations, seeking advice from a tax professional can save you time and money. A tax professional can help you navigate intricate tax laws, identify potential deductions and credits, and ensure your return is accurate. They can also provide guidance on tax planning strategies to minimize your tax liability in the future. 

If your small business operates in multiple states or you’re looking to expand, checking with a professional helps you get ahead of unexpected state tax situations. And if you have multiple sources of income, own a business, or have experienced significant life changes, consulting a tax professional can provide peace of mind and help you manage your state taxes more effectively.

Take control of your taxes. 

Taxes are a fact of life for everybody, but if you run a small business, the combination of local, state, and federal taxes can be a lot to keep track of. Ensuring all calculations and withholdings are correct requires attention to detail and a load of paperwork. 

Not to mention, figuring out how to calculate state income tax could cost you valuable time and effort, especially if your team is spread across states. Nobody wants to risk a compliance issue, but every minute spent on payroll is time away from helping your business thrive. 

That’s what Homebase is here for. As an all-in-one app for hourly teams, Homebase helps small business owners manage teams with time tracking and scheduling functions that connect directly to our payroll tool. Get started today and let Homebase automatically calculate taxes for you so you can take back your time.