State & Local/City Tax

Taxation is complex. We provide below what we believe are the key highlights for this tax type in a 2-3 minute read for reference purposes. It is not tax advice and does not discuss the vast majority of the finer points.

What Is State Income Tax? When/How Does It Apply?

State income tax refers to a tax levied by states on the income earned by individuals and businesses within that state. State income tax rates and policies vary significantly across the U.S. As of 2023:

• 7 states have no state income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming

• 1 state taxes only interest and dividend income: New Hampshire

• 11 states have a flat income tax rate: Colorado, Illinois, Indiana, Kentucky, Massachusetts, Michigan, North Carolina, Pennsylvania, Utah, New Mexico, and Rhode Island

• 30 states have a progressive income tax with higher rates for higher income levels. Rates range from 2.5% in Arizona up to 13.3% for top earners in California.

State income taxes apply to income earned from working, investing, or owning a business within a state’s borders. Most states follow the federal definition of taxable income, but some make modifications. State income tax liability generally depends on an individual’s residency status:

• Residents: Owe state income tax (if applicable) on all taxable income earned in the state.

• Nonresidents: Owe state income tax only on taxable income earned from sources within that state. Income from other states or sources is not taxed.

• Prior/partial residents: Taxed for the portion of the year lived in the state. The nonresident portion of income is typically taxed based on the ratio of income from that state to total income.

Most states require residents and nonresidents who earn income within their borders to file a state income tax return in addition to a federal return. State returns are typically due at the same time as federal returns, around April 15th annually.

The tax implications of your residency status can be complex. If you earn income in multiple states or may qualify as a part-year resident, consult a tax professional to determine your state income tax liability accurately. They can also advise you on any opportunities to reduce your overall state income tax burden through credits, deductions, or planning strategies.

For more information, visit: 🔗The Tax Foundation (State Income Tax)

Most states treat capital gains as income, taxing it the same as other earned income.

What Is Local Income Tax? When/How Does It Apply?

In some states, cities and counties are authorized to levy a local income tax on top of any state income taxes owed. As of this writing, 16 states have at least one local government district that charges a local income tax: Alabama, Colorado, Delaware, Illinois, Indiana, Kentucky, Maine, Maryland, Michigan, Missouri, New Jersey, New York, Ohio, Pennsylvania, West Virginia, and Wisconsin.

Local income tax rates vary significantly depending on the locality. Most range from 1% up to 4% of taxable income earned within that city or county's borders. Some cities have a flat local income tax rate, while others use a progressive structure with higher rates for higher income levels. Local income taxes typically apply via the same criteria used to determine state income tax liability:

• Residents: Owe local income tax (if applicable) on all taxable income earned within the city/county.

• Nonresidents: Owe local income tax only on taxable income earned from sources within that city/county. Income from other localities or sources should not be taxed.

• Prior/partial residents: Taxed for the portion of the year living in the city/county. The nonresident portion of income is typically taxed based on the ratio of income from that city/county to total income.

Most localities that assess an income tax require residents, nonresidents, and part-year residents to file a separate local tax return in addition to state and federal returns. Returns are typically due at the same time, around April 15th.

The rules around local income taxes can be complex, especially for individuals who earn income or may qualify as residents of multiple cities/counties within a year. Consulting a tax professional is recommended to determine your local tax liability accurately and look for opportunities to minimize your total local income tax burden. They can advise you on any special considerations regarding your locality’s income tax rates, policies, and filing requirements.

For more information, visit: 🔗The Tax Foundation (Local Income Tax)

What Are the Current Tax Rates/Brackets?

State and local taxes vary significantly, and it's outside the scope of this article to provide accurate and updated information for each jurisdiction. For info on current tax rates and brackets visit: 🔗The Tax Foundation (State Income Tax) 🔗The Tax Foundation (Local Income Tax)

Withholding Requirements

On average, most states and/or localities that assess income tax also require employers to withhold the income tax from paychecks when it's earned. That said, state and local taxes vary significantly, and so do the rules (including withholding obligations).

What Types of Stock Compensation Does This Apply To?

There is too much nuance across states and stock comp types to be able to comfortably provide specific information on if/when state/local taxes are likely to apply.

That said, in general, most states tax earned income, passive income, and capital gains the same. If your state/locality assesses income taxes, it's reasonable to assume that any and all activities that generated income or capital gains are likely to be taxed.

Unique Items and Special Tax Situations to Consider

While state and local income taxes generally follow standard rules based on where you live and earn income, there are some unique situations that can impact your tax liability:

Income Tax Liability Depends on Where Income Is Earned, Not Where You Live

If you live in one state but work in another, you will owe income tax to the state where your job is located. You may need to file nonresident or part-year resident returns in multiple states.

Relocating During the Year

If you move to a new state during the tax year, you will likely need to file a part-year resident return in both your previous and new state of residence. Each state will tax the income earned while living there, typically on a pro-rata basis.

Stock-Based Compensation Taxation When Relocating Is Complex

The taxation of equity compensation like stock options, restricted stock, and RSUs depends on where you lived and worked when the shares were granted and vested. If either location changes during the year, pro-rata rules apply based on the number of days in each state. For example, if you lived in California and had an NSO grant 50%, then moved to Texas and the remaining 50% vested --> when you exercise it (living in Texas), 50% of that income will be sourced to CA and 50% to Texas. If this applies to you, we strongly recommend consulting a tax professional.

State Unemployment and Disability Insurance Taxes Can Be Complex

In addition to income taxes, most states collect unemployment insurance tax and disability insurance tax withheld from employee paychecks. Rates and policies for these payroll taxes differ in each state according to their laws.