Why Didn’t Income Taxes Come Out of Employee Payroll?

Background

There are a number of things that can shake up employee withholding for payroll. If you are wondering why federal or state, or local income taxes didn’t come out of an employee’s paycheck, check out some possible reasons below:

Why didn’t Federal or state income taxes come out of employee pay?

Reason #1 – The employee didn’t make enough money for income taxes to be withheld.

The IRS and other states had made sweeping changes to employee withholding along with the change of the employee W-4 in 2020. The new W-4 reflect changes to the federal tax code from the Tax Cuts and Jobs Act. The IRS says the redesign was made to have withholding match employee liability. In many cases, reducing income tax withholding, or not withholding any income taxes at all.

These are the factors considered in the withholding calculation: 

1. Rate of pay
2. Pay frequency
3. The dollar amount of dependents (Step 3 of the 2020 W-4)
4. Filing status

When calculating income tax deductions for payrolls, the software takes all of the above into account.

Let’s say an employee hasn’t had any withholding taken out. Look to see the “allowances” (if a 2019 or earlier W-4 was used) or the dollar amount of dependents (section 3 of the 2020 W-4) the employee claimed on their W-4. A high number of allowances or dollar amount of dependents reduces the amount of income taxes the software takes into account. 

Next, check what the pay frequency is for the employee. You can do this by going to:

Payroll > Employee List > Click Employee name > Pay Info.

You will want to make sure that the software is set with an accurate pay frequency for the employee. For example, an employee who receives $1,000 each payday—which is set to weekly—has a very different annual income than an employee who gets paid a salary of $1,000 but only gets paid monthly.

Filing status also makes a difference in payroll income tax calculations. A Single filing status generally will have more taxes taken out than a Married or Head of Household. 

If an employee wants more federal income taxes withheld from their paycheck, they can fill out a new withholding form and request an amount to be withheld in the extra withholding box Step 4c on the 2020 W-4.

Please note that when changing from the 2019 W-4 to the 2020 W-4, the tax withholding amounts have changed. The Tax Cuts and Jobs Act took effect in 2019, which required the IRS to redesign the 2020 Form W-4 employee withholding certificate in order to make accurate income-tax withholding easier for employees.  Employee tax withholdings are lower when using the 2020 W-4 new form.

Reason #2 – The employee is marked exempt from federal or state income tax withholding.

Check the withholding setting for the employee and see their current exemption status by going to:

Payroll > Employees > Employee List > Click the Employee Name > Taxes

If you need to change the setting, please refer to our help article, “EDITING EMPLOYEE TAX INFORMATION.”

One, quick thing to note, just because an employee is “exempt” from income taxes, it doesn’t make them exempt from taxable wages. The employee W2 will still show all taxable wages earned by the employee, even if they didn’t have any income taxes withheld.

Reason #3 – The setting for “choose to withhold” income tax for an employee who lives in a different state was not selected in the software.

While you are automatically required to withhold income taxes in the “work state” if the employee lives in a different state, the employer has the option to offer withholding in most cases. The employer can sometimes withhold for a resident state if certain requirements are met.  

You can check this setting by going to:

Settings > Payroll Settings > State Tax Withholdings

Tab to the state and see if “Yes” (withhold) or “No” (do not withhold) in the field “Withhold Income Tax” was selected.

Please refer to our help article Handling Multi-State Tax Withholding in Patriot Software, for more information.

Reason #4  – You indicated you had a ‘non-resident’ certificate from the employee.

Does the employee have their own ‘resident’ (home) state income taxes being withheld instead of income taxes for the work location? If so, the field for ‘non-resident’ certificate may be selected.

If there is reciprocity between the work state and the home state, the software will apply the tax rules to determine which state to withhold. 

You can check this setting by going to: 

Payroll > Employees > Employee List > select Employee Name > “Taxes” link at the top > Edit.

There you will see the field for “Non-resident Certificate“. This field indicates either “Yes” (you have a non-resident certificate on file) or “No” (you don’t have a non-resident certificate).

For more information on non-resident withholding, please refer to our help article NON-RESIDENT CERTIFICATES FOR EMPLOYEES IN OTHER STATES.

Reason #5 – Special rules applied for state resident nexus and/or reciprocity.

Withholding can get complicated when an employee lives in one state but works in another. Each state’s laws of reciprocity and resident/nonresident taxation rules are taken into account. Patriot keeps track of these rules and will not withhold or reduce withholding based on state laws.

The following states have special rules or withholding formulas in place for resident employees working in another state:

• Alabama residents working outside the state for an employer who is not based in Alabama are not subject to Alabama withholding. However, the employee is still subject to taxation on all wages at the end of the year.
  
• Arkansas residents who work in another state are only subject to Arkansas withholding on wages earned if the work state does not have income tax laws.
  
• Colorado residents who work in another state with income taxes withheld on wages earned in the work state are excused from Colorado withholding.
  
• Idaho withholding is not supported by an Idaho resident working in another state. Idaho law states that residents working outside the state are not subject to Idaho withholding regardless of whether the other state has income tax or not.
  
• Illinois residents working outside the state of Illinois can have income tax withheld, even if the other state withholds income tax from wages earned within that state (unless the other state has a reciprocal agreement with Illinois).
  
• Georgia residents working outside the state are not subject to Georgia income tax withholding if their compensation is subject to withholding in their work state.
  
• Minnesota residents working outside the state do not have to have MN income tax withheld if the work state income tax exceeds MN tax liability. If the work state does not exceed the MN liability limit, the difference for MN should be withheld.
  
• Mississippi residents working outside of the state do not need to have Mississippi income tax withheld if the work state requires withholding for income taxes.
  
• Missouri employee withholding is only withheld if the MO resident works in a different state with a lower rate than Missouri state tax.
  
• Montana residents are not subject to Montana withholding if they work in another state, even if the work state does not have income taxes.
  
• Nebraska residents are subject to Nebraska income tax withholding even if working in another state. However, the amount of Nebraska income tax due is decreased by the amount of the work state withholding.
  
• North Dakota residents working in another state are not required to withhold North Dakota taxes if the work state requires income tax withholding.
  
• Ohio residents working outside of the state are not subject to Ohio withholding if the work state requires income tax withholding on wages worked there.
  
• Oklahoma residents working in another state are not subject to Oklahoma withholding on wages unless the work state does not have an income tax law.
  
• Oregon residents working outside the state are only subject to Oregon withholding if the employer is located in Oregon.
  
• Pennsylvania residents who work in another state are not subject to PA income tax withholding if the work state has income taxes being withheld from wages earned there. If no income taxes are required in the work state, then PA income taxes must be withheld.
  
• Utah residents who have a Utah employer but work in another state must have Utah income taxes withheld for the excess of the withholding requirements of the work state.
  
• Virginia residents working in another state who are taxed from the work state will receive credits for taxes owed to Virginia. However, employers are not required to withhold Virginia tax from the wages of Virginia residents earned outside the state, unless the other state or jurisdiction has no income tax or if there is a reciprocal agreement between Virginia and the work state.

Reason #5 – There is no income tax withholding imposed for the state.

The following states do not have income tax withholding requirements.

Here’s an article on income withholding for more info: What Is State Income Tax?

Why didn’t local taxes come out of employee pay?

Reason #1 – The company tax jurisdiction is set to “no local tax.”

You can check this setting at the work location by going to:

Settings > Payroll Settings > Tax Location 

To see available options, click the “Change” link to the right of the field. There, you will see a drop-down of all available choices based on the address and zip code entered for the work location. You can select the correct tax jurisdiction and click “Save.” 

Reason #2 – The employee is set to “exempt” from local taxes.

You can check the settings for the employee by going to:

Payroll > Employee List > Select the employee name > Taxes

There, you can scroll down to see if the local tax “current setting” is set to “Exempt.” If you need to edit this setting, please refer to our help article Editing Employee Tax Information.

Reason #3 – The wrong tax jurisdiction was selected for the employee.

The software is programmed to calculate taxes based on the jurisdiction selected. If you are expecting a local tax to come out, check the local tax field to ensure that the correct jurisdiction was selected. Payroll> Employee List > Select Employee Name > Taxes > Scroll to the Local taxes section.

There, you can see the choices for the drop-down for local taxes. If you don’t find the local tax you are expecting, please check to ensure the employee zip code is accurate.

Reason #4 – There are no local taxes effective for the tax jurisdiction.

In the software for states with local or school district taxes, a drop-down is provided for users to select employee tax jurisdictions. But, it doesn’t mean that all tax jurisdictions have active taxes, however. If the software does not calculate a local tax you thought would come out, check with the local tax agency to see if there is a local payroll tax in effect. The upside to selecting the correct tax jurisdiction is when taxes are effective, the software will properly begin withholding from the employee.

Reason #5 – The software does not support local income tax courtesy withholding for employees that work in one state but live in another state with local income taxes imposed. 

The only local courtesy withholding the software supports at this time is in the state of Ohio for employees who both live and work in Ohio.

For all other states, the employee will need to pay any resident local income taxes at the end of the year on their income tax return.

Still stumped on why didn’t income taxes come out of employee payroll? Feel free to reach out to our support team. We’re available by chat, phone, or email 9:00 a.m. – 7:00 p.m. ET M- F.

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