Local Income Tax

A local income tax is a tax on income imposed by a unit of government below the state: a city, a township, a county, a school district or a special district, acting under authority a state legislature has granted. There is no single national design. Rates, bases, who administers the tax and even what it is called differ from state to state, and within a state a taxpayer can sit inside more than one taxing jurisdiction at once.

The feature that separates a local income tax from the taxes above it is the weight it puts on the workplace. Federal and state income taxes start from residence and then source particular income elsewhere. Ohio's municipal income tax statute reaches, in the case of nonresidents, "all income, salaries, qualifying wages, commissions, and other compensation from whatever source earned or received by the nonresident for work done, services performed or rendered, or activities conducted in the municipal corporation." Someone who lives in one town and works in the next can therefore owe income tax to a place they have no other connection with.

Because the workplace rule reaches short visits, states that use it have to write an exemption, and the exemption is where the detail lives. Ohio Revised Code 718.011, headed "Occasional entrant exemption," provides that an employer is not required to withhold municipal income tax on wages paid for services performed in a taxing municipality where the employee performed those services "on twenty or fewer days in a calendar year." Four situations disapply it: the employee's principal place of work is in the municipality; the services were at a presumed worksite location, meaning a site the employer can reasonably expect to last more than twenty days; the employee is a resident who has asked for withholding; or the employee is a professional athlete, professional entertainer or public figure paid in that capacity, which is what jock tax describes.

"Principal place of work" is defined in a cascade, and the last step is a tiebreaker most people would not guess. It is the fixed location an employee is required to report to on a regular and ordinary basis. Failing that, the worksite location they must report to regularly. Failing that, "the location in this state at which the employee spends the greatest number of days in a calendar year performing services." And where two or more municipalities tie on days, the employer allocates the wages between them "using any fair and reasonable method."

One clause in that section has an outsized effect on remote work. Ohio's definition of a worksite location ends: "'Worksite location' does not include the home of an employee." Pennsylvania's Department of Community and Economic Development takes the opposite line for its own scheme, listing among examples of business worksites "factories, warehouses, branches, offices and residences of home-based employees." Two states, two answers, and an employee's kitchen table is a taxable worksite in one and not in the other.

Pennsylvania's design is different enough to make the general point. Under Act 32, employers with worksites in Pennsylvania are required to withhold and remit both a local Earned Income Tax and a Local Services Tax on behalf of employees working in the state. Jurisdictions are identified by a code system, and the employee completes a Residency Certification Form which the department describes as an "Addendum to Federal W-4 Form." So one state runs its local income tax through municipal collectors and a code lookup bolted onto the federal withholding form, while another runs it through a day-count exemption and a definition of principal place of work.

The name Pennsylvania uses is a trap worth flagging. Its local tax is called the Earned Income Tax, which is a completely different thing from the federal Earned Income Tax Credit. The two share four words and nothing else.

New York adds a third shape. Its Yonkers nonresident earnings tax is a local tax on wages derived from Yonkers sources, and the state applies the same convenience of the employer rule to it that it applies to the state income tax for nonresidents. So a local tax can inherit a state's sourcing doctrine wholesale rather than having one of its own.

On the federal return these taxes sit inside a single, capped deduction. State and local income taxes are one limb of the itemized deduction for state and local taxes, alongside property taxes and, by election, sales taxes. The cap and the mechanics belong to the SALT deduction; the only point to carry here is that a local income tax is not deducted separately from a state one.

How many places levy one is not a question with a citable answer. There is no national register of local income taxes, jurisdictions adopt and repeal them, and school districts and special districts complicate any count. The mechanism generalizes; a number does not.

How liability is worked out in a work-site state.

1. Identify every taxing jurisdiction the employee worked in, which for some jobs means several in one week.

2. Find the principal place of work using the statutory cascade: a fixed reporting location, then a regular worksite, then the municipality with the most days, then a fair and reasonable allocation if two tie.

3. Count days in each other jurisdiction and apply the short-visit exemption where it survives, remembering the four exceptions.

4. Withhold and remit to the principal place of work, and to any other municipality once its threshold is passed.

5. Reconcile on the local returns, which are separate from the state return and often filed with a municipal collector rather than the state.

A hypothetical example, using Ohio's twenty-day rule. Ravi is a field technician whose fixed reporting location is in City A, so City A is his principal place of work and the exemption never applies there. During the year he also works 12 days in City B and 30 days in City C. Assume he earns $500 of qualifying wages a day and that City C's rate is 2 percent; both figures are stipulated for the illustration.

City B is at twelve days, inside the twenty-day threshold and outside all four exceptions, so his employer is not required to withhold City B tax at all.

City C passes twenty days during the year, so from day twenty-one the employer must withhold for City C. That is 10 days of wages, or 10 times $500, which is $5,000, and $5,000 times 0.02 gives $100 of City C tax.

The employer may instead elect to withhold City C tax on the first twenty days as well. If it does, the statute makes the tax withheld and paid for those first twenty days to the municipality that is Ravi's principal place of work refundable to him, so the election shifts money between two cities rather than costing him more.

What local income taxes do well

• They let a city fund services for the daytime population that uses them, including commuters who consume roads, transit and emergency services without paying property tax there.
• They are collected through payroll, so for most employees compliance is automatic and invisible.
• Rates are typically low against state and federal rates, so a mistake in either direction is usually small in dollar terms.
• Where a state has built a statutory framework, as Ohio and Pennsylvania have, the rules for multi-jurisdiction workers are at least written down.

The costs and the traps

• The number of jurisdictions is the problem. A worker moving between sites can owe several small amounts and file several small returns.
• Designs differ by state, so experience in one is a poor guide to another, and a home office is a taxable worksite in some schemes and expressly not in others.
• Day-count thresholds put a record-keeping burden on employers and, when an employer gets it wrong, on employees who have to sort out a refund.
• Local returns often go to a municipal collector rather than the state revenue department, so the filing is easy to overlook entirely.
• The federal deduction for these taxes shares a single cap with property and state income taxes, so for many households the local tax produces no federal relief at all.