Payroll is one of a series of accounting transactions dealing with the process of paying employees for services rendered, after processing of the various requirements for withholding of money from the employee for payment of payroll taxes, insurance premiums, employee benefits, garnishments and other deductions.
Payroll involves the calculation of amounts due the employee, such as hourly wages, a salary consisting of a certain amount per calendar period, or pay to salespersons on commission, as well as reimbursement for employee-paid expenses such as travel (calculated either based on actual amount paid by the employee or utilizing a per diem rate).
In addition to these payments, there are often computed amounts of paid vacation time and accrued sick leave which have been used or are available for use. These are simply carried as bookkeeping entries as available or used and accumulate until the employee actually uses them. If an employee collects vacation pay or sick leave, these amounts are then added to the amount due the employee to be paid.
All of these monies credited to the employee are usually referred to as gross pay.
From these amounts that are credited to the employee, various debits are taken as withholding, the most significant being income tax, then other taxes such as social security and Medicare (in the United States; other countries have similar programs for the collection of government-mandated retirement benefit supplement systems). There may also be additional deductions for supplemental health insurance, union dues, pension plan contributions, garnishment for nonpayment of debts, repayment of prior salary, vacation or sick leave overpayments made in error, undercollection of insurance, and other deductions.
The amount left after deductions from gross pay is generally the amount given in the employee's pay envelope, either as cash or a check. This amount is known as net pay. If the employee has their net pay deposited to their bank account (through a process known as direct deposit) then the employee may simply receive a pay stub indicating this.
In addition to amounts collected from the employee, frequently the employer is required to also pay additional monies of their own such as government taxes such as employer matching contribution to Social Security, and employer-paid systems such as unemployment insurance; employer matching for pension plans such as 401(k); employer portion (or all) of employee health insurance, and additional expenses.
Organizations which have very few employees may perform payroll by hand. Business organizations which have become too large to perform such tasks by hand (or small ones that prefer not to do them by hand) will generally use an accounts software, or an integrated module from a Human Resource Management System on a computer to perform this task, or may pay a service bureau to perform the process of payroll calculation and writing of payroll checks.
Due to government mandated (and often severe) penalties for improper or inadequate collection of payroll taxes and paying of wages, almost all employers (other than very tiny ones having perhaps one or very few employees) either use a payroll computer program or a service bureau.
Payroll taxes in U.S.
Before considering the payroll taxes we need to talk about the Basic Formula for the Net Pay. Basically from gross pay is subtracted one or more deductions to arrive at the Net Pay. In fact Employee's gross pay (pay rate times number of hours worked, including any over time) minus payroll tax deductions, minus voluntary payroll deductions, is equal to Net Pay. As you can see payroll tax deductions play a critical role and just because they are provided by law we can call them Statutory payroll tax deductions.
The employer must withhold payroll taxes from an employee's check and hand them over to several tax agencies by law. Payroll taxes include:
- Federal income tax withholding, based on withholding tables in "Publication 15, Employer's Tax Guide" by Internal Revenue Service - IRS;
- Social Security tax withholding. The employee pays 6.2 percent of the salary or wage, up to 106,800. The employer also pays 6.2 percent in Social Security taxes. If you are self-employed, you pay the combined employee and employer amount of 12.4 percent in Social Security taxes on your net earnings;
- Medicare tax. The employee pays 1.45 percent in Medicare taxes on the entire salary or wage. The employer also pays 1.45 percent in Medicare taxes. If you are self-employed, you pay the combined employee and employer amount of 2.9 percent in Medicare taxes on your net earnings;
- State income tax withholding;
- various local tax withholding, such as city taxes, county taxes, school taxes, state disability, and unemployment insurance.
As for the sources considered as references we can mention the following publications:
- Publication 15, (Circular E), Employer's Tax Guide. This publication explains employer's tax responsibilities. It explains the requirements for withholding, depositing, reporting, paying, and correcting employment taxes. It explains the forms any employer must give to its employees, those employees must give to the employer, and those employer must send to the IRS and SSA (Social Security Administration). This guide also has tax tables needed to figure the taxes to withhold from each employee;
- Publication 15 - A, Employer’s Supplemental Tax Guide. This publication supplements Publication 15 (Circular E), Employer’s Tax Guide. It contains specialized and detailed employment tax information supplementing the basic information provided in Publication 15 (Circular E);
- Publication 15-B. Employer's Tax Guide to Fringe Benefits. This publication supplements Publication 15 (Circular E), Employer’s Tax Guide, and Publication 15 - A, Employer’s Supplemental Tax Guide. This publication contains information about the employment tax treatment of various types of noncash compensation.
In the earlier part we have considered payroll taxes related to employee's side. Now it's the moment to talk about the Employer Payroll Taxes Employers are responsible for paying their portion of payroll taxes. These payroll taxes are an expense over and above the expense of an employee's gross pay. The employer-portion of payroll taxes include the following:
- Social Security taxes (6.2% up to the annual maximum);
- Medicare taxes (1.45% of wages);
- Federal unemployment taxes (FUTA);
- State unemployment taxes (SUTA).
Very often you can hear people using FICA in their terminology. FICA stands for the Federal Insurance Contributions Act and the FICA tax consists of both Social Security and Medicare taxes. As we explained earlier both parties pay half of these taxes. Employees pay half, and employers pay the other half. Social Security and Medicare taxes are paid both by the employees and the employers. In summary together both halves of the FICA taxes add up to 15.3 percent.
Any employer is responsible for paying the employer's share of payroll taxes, for depositing tax withheld from the employees' paychecks, preparing various reconciliation reports, accounting for the payroll expense through their financial reporting, and filing payroll tax returns. As you see this suite of employer payroll tax responsibilities is far above issuing paychecks to employees.
Different Types of Accounting
- Institute of Payroll Professionals official website
- Glossary of Accounting Terms
- Independent research, seminars and consulting on multi-country payroll
- Direct Deposit information resource
- Publication 15 (2010)(Circular E) Employer's Tax Guide
- AICPA Financial Management Center – Resource for CPAs working in business, industry and government.
- Revsoft Payroll Service Provider Specialists - Case Study helping to understanding payroll software in the market
- Practical Managerial Accounting Service - Information in managing your time effectively and swiftly
- Accounting Practice Management Software Solutions | Account Payee - External resource on additional management practice solutions
- Publication 15 (2010), (Circular E), Employer's Tax Guide
- SSA Publication No. 05-10003, January 2010, ICN 451385
- SSA Publication No. 05-10003, January 2010, ICN 451385