It's almost never correct to remove a Federal or State tax from an employee's record. Here are the following situations where it's correct to exempt an employee from Federal or State tax or State selection on their record:
The employee lives or works outside of the US.
It's possible that the employee is subject to withholding in their home state, but since they work in another country, the SUI and/or SDI taxes aren't due on that employee. Check with your state agencies to be sure.
The employee has a special status.
For example, they aren't a U.S. citizen or are on a special visa. In this case, they are subject to some taxes and may be exempt from others. Read the rules carefully or get professional advice for this special situation.
The employee is working in a U.S. protectorate such as Guam.
In this case, QuickBooks doesn't support any "state-level" taxes for the employee directly. Leave the "state worked" and "state lived" blank, but set up any applicable local taxes as custom taxes, whether employee- or company-paid. QuickBooks supports both types of custom taxes.
The employer has a special tax-exempt status.
For example, a charity, church, or government organization may have a special status at the Federal or Dtate level. If you're sure you fall into this category, then deselecting some taxes may be appropriate.
Many employers make the mistake of removing a tax from the employee record when they shouldn't. Doing this incorrectly causes significant "downstream" problems that affect reports, tax forms, tax calculations, and liabilities due.
Common reasons why employers mistakenly remove a tax from an employee's record
The tax is company-paid.
QuickBooks knows which taxes are company-paid and which are employee-paid. All are added to the employee record based on "state lived" and "state worked," but only those that the employee pays are deducted from gross pay.
The tax rate is 0%.
Some employers confuse the case where the tax rate is 0% with being "not subject to" the tax. Typically, you're subject to a tax even when your rate is 0%, and you must report wages for the tax. If this is the case, you should include the tax on the employee's record, and set the rate to 0% on the Payroll Item list.
The employee claims "exempt" status.
Typically this means that the employee is claiming that they won't owe Federal or State withholding at year end due to hardship, high deductions, or low income status. This doesn't mean they aren't subject to the tax. "Subject to" and "exempt from" are two different but confusing concepts. For example, if you live or work in the US, you're usually subject to Federal tax. However, you may claim to be exempt from withholding. In this case, you should select "Do Not Withhold" as the withholding status.
My state doesn't collect this tax.
In QuickBooks, all employees who live or work in the US should have a "state lived" and "state worked" selected, even when the state doesn't collect that particular tax. For Enhanced Payroll service customers, this means that employees are identified with a state and are included on the state forms. Employee mailing addresses aren't used to determine an employee's locality.
The employee paid the tax while working for a previous employer this year.
In this case you're almost always required to withhold the tax again and the employee must file for a refund at the end of the year. You would also have to withhold tax even if the employee met the SDI and SUI limits while working for a previous employer.
I don't think I owe this tax.
For Federal and State taxes, this is unlikely. Almost all employers owe the taxes QuickBooks suggests.
The company has agreed to pay a tax that is usually paid by the employee.
This is a rare case. Even if it's correct, it's not supported by QuickBooks and your tax forms will be incorrect.