Table of Contents
What Are Payroll Liabilities?
In accounting, a liability is an obligation to pay an amount. Any expense associated with processing payroll is considered a payroll liability.
Types of Payroll Liabilities
Before payroll is processed, employees’ wages are a liability. In addition to wages earned for completing work, bonuses and severance obligations are also types of compensation liability.
Paid Time Off
Paid time off (PTO) is compensation for time away from work. In the context of payroll liabilities, typically there is no distinction between vacation, flex, or sick days. From an accounting perspective, an employee’s available PTO is considered a liability since it’s “owed.”
Federal income tax is paid by the employee, typically through payroll deduction; FICA is Social Security and Medicare taxes paid by both the employer and the employee. Normally it is the employer’s responsibility to pay unemployment tax; however, there are a few states in which the employee contributes. Lastly, state and local taxes may also apply.
Payroll Service Costs
How to Keep Track of Payroll Liabilities
Organizations must keep track of their payroll liabilities to mitigate risks of potential errors, late payments, etc. To ensure that the operations of your business run smoothly, use these tools.
The IRS states that “every employer engaged in a trade or business who pays remuneration for services performed by employees must report to the IRS the wage payments and related employment taxes, including income tax withholding, social security tax, Medicare tax and if applicable, Additional Medicare tax. Generally, employers must report wages, tips and other compensation paid to an employee by filing the required Form 941, Employer’s QUARTERLY Federal Tax Return.”
In order to complete these reports and payments to the IRS, you’ll need copies of those documents from your records.
Now that you have your payroll documents, set up reminders as to when payments are due. The best way to do so is to use an electronic calendar such as Outlook. Many payroll vendors share reminders as well.
Alternatively, payroll software organizations provide services such as wage and tax calculations and payment of your tax liabilities on your behalf.
How to Pay Payroll Liabilities
Not paying payroll liabilities, or not doing so on time, can be costly. Here is a general outline of the process.
Step 1: Collect Employee Data
Step one is to gather your employee information. The best source for this information is the employee’s W-4 form. The W-4 provides pertinent information such as the personal information of your employee (e.g social security number, address) and tax information.
Step 2: Calculate Gross Wages
Next, determine your employees’ gross wages. This step is important because payroll tax liabilities and voluntary deductions are based on a percentage of the employee’s gross wages. Gross wages include but are not limited to items such as commission, overtime pay, piece rate pay, tips, and bonuses.
Step 3: Calculate Withholdings
A tax withholding is when an organization withholds a portion of an employee’s gross wages for tax purposes. The amount withheld is contingent upon the employees’ gross wages.
You must withhold federal income tax, social security, Medicare tax (FICA), and, if applicable, state and local taxes. To calculate your employees’ FICA tax, multiply the employees’ gross pay by the Social Security tax rate (6.2 %) and the Medicare rate (1.45%). Since the rates are the same for employers and employees, once you’ve calculated the employee contribution, you know the employer portion as well.
Step 4: Deductions
Next, account for voluntary deductions such as health and dental insurance. The order in which deductions are taken is key because some deductions are pre-tax and some post-tax.
For pre-tax deductions, subtract the deduction from the employee’s gross wages before you calculate taxes. For post-tax deductions, subtract the deduction after you calculate taxes.
Step 5: Record Liabilities
Record your payroll liabilities based on the accounting principle of the accrual method. This method matches revenues and expenses. Therefore, you’ll record your payroll expenses in the month they are incurred, not when the expenses are paid. These entries are recorded in your organization’s general ledger.
Step 6: Pay Liabilities
There are a number of ways you can pay liabilities.
- Employee wages can be paid via check, direct deposit, and/or by a check card.
- Use Form 941 to report and file Federal income, Medicare and Social Security taxes.
- Use Form 940 to report and file Federal Unemployment Taxes (FUTA).
- Deductions can be paid to the appropriate vendor either by check or ACH.
Payroll Liabilities Best Practices
There are a few best practices to help reduce your organization’s risks.
- Always keep secure copies of your payroll documents.
- Make sure you have enough available cash to pay your employees and other liabilities.
- Keep payroll separate by opening an account designated strictly for payroll.
- Create and maintain a Payroll Policies Guide: a step-by-step guide on how to process your payroll.
- Use a payroll vendor. Using a payroll vendor saves employers time and money. Furthermore, by utilizing a payroll vendor whose sole responsibility and expertise is payroll minimizes chances of errors, missed deadlines, omissions, or late payroll tax filings.
Questions You’ve Asked Us About Payroll Liabilities
The key difference between payroll expenses and liabilities is that payroll liabilities are listed on the balance sheet and payroll expenses are listed on the income statement. Payroll expenses are the cost of doing payroll while payroll liabilities are the amounts owed (debt).
Adjusting payroll liabilities refers to correcting a mistake in accounting and reporting (usually software). How to complete this task varies depending on the method or software used.
Wendy is an HR professional with over 10 years of HR experience in education and health care, both in the private and non-profit sector. She is the owner of KHRServices, a full service HR management agency. She is also SHRM and HRCI certified, serves as a HRCI Ambassador, and voted 2021 Most Inclusive HR Influencer.