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Basic Payroll Accounting

Excel employee payroll

If you own a small business, you record your employees’ payroll not only to give them their proper salaries but also to comply with state laws and taxes. This article will teach you how to do basic payroll accounting.

What is Payroll Accounting?

Payroll accounting is the system by which you use journal entries to record payroll expenses in your books. Payroll accounting is not an easy job. Payroll journal entries form part of your payroll account and are essential to your business general ledger as a whole. Expenses entered in the payroll account include gross salaries, wages, other income as well as deductions for taxes.

An Overview of Payroll Liabilities and Expenses

Your payroll transactions are recorded in the journal. Usually, three accounts are affected by payroll transactions: expenses (amounts already paid), liabilities (amounts owed but not yet paid) and assets (normally, cash). Below are some common payroll entries:

  • Gross salaries and wages
  • FICA tax payable
  • Federal income withholding tax payable
  • State income withholding tax payable
  • Payroll payable (wages you owed but haven’t paid yet)
  • Other deductions made (an example of this is retirement contribution)

As you do your payroll transactions, you record debits and credits to your ledger. Debits and credits are made depending on the type of transaction made. The important thing to remember is that your debit should equal your credit.

It is important to have a basic knowledge on which accounts are debited when increased and credited when decreased. In the same way, some accounts are debited when decreased and credited when increased. The table below will give you a basic understanding of the accounts involved in accounting.

 

ACCOUNT NAME INCREASED BY DECREASED BY
Asset Debit Credit
Liability Credit Debit
Owner’s Equity (Capital) Credit Debit
Revenue Credit Debit
Expense Debit Credit

 

It is important to know here that assets, liabilities and owner’s equity are called real accounts or balance sheet accounts. It is because the ending balance computed at the end of the year for these accounts are carried over to the beginning of the year. On the other hand, revenue and expenses are considered nominal accounts because their ending balances are closed at the end of the year. At the start of the accounting period, their beginning balances are zero.

With payroll accounting, you work with expenses, liabilities and assets.

Recording Journal Entries in the Payroll General Ledger

At first glance, payroll accounting can be intimidating because of the process of recording. Keep in mind the table above and follow these steps to learn how to record payroll accounting with ease.

  1. Record payroll expenses.

The primary journal entries in the payroll general ledger are expenses. Expenses include anything payroll-related that you paid during an accounting period. Expenses are already paid amounts and since they increase your expenses, debit your expense account. Debit the wages, salaries and company payroll taxes you paid. This increases your expenses for the period.

  1. Record liabilities (payroll payables)

The second step is to record the amounts you owe but haven’t paid or your liabilities. You gain liabilities because you owe payroll. Liabilities increased through credits. Credit the FICA tax payable, federal income withholding tax payable, payroll payable (wages earned but not yet paid) and other deductions. This increases your liabilities for the period.

  1. Record transition accounting entries

You will have to pay amounts you owe to your employees and remit the taxes to the government. Paying your liabilities will decrease them, therefore debiting the liabilities account. In the same way, your asset or cash decreases as you pay your liabilities. Asset decreases with credit.

Payroll Journal Entry Example

To further understand, below is a concrete example of how a payroll journal entry is made.

For example you have an employee in your payroll. His data are as follows:

  • Gross Salaries and Wages- $500
  • FICA tax payable computed (employee)- $61.20
  • Federal income tax payable as computed- $60
  • State income tax payable as computed- $20

Following the steps above, your firs journal entry would look like this:

Journal Entry #1

Account                                            Debit                                         Credit

Gross Salaries and Wages                     500.00

FICA Tax Payable (Employee)                                                                    61.20

Federal Income Tax Payable                                                                      60.00

State Income Tax Payable                                                                          20.00

Wages Payable                                                                                            358.80

 

Notice how the expense account is debited and your liabilities are credited because both accounts increased.

Journal Entry #2

          Account                                            Debit                                      Credit

Wages Payable                                              358.80

Cash                                                                                                                    358.80

 

This happens when you pay your employees. Your payables decrease so you debit your liabilities account in the same way that your cash decreases therefore crediting your asset account.

Journal Entry #3

When the time comes you have to remit your taxes to the government, the entry is as follows:

Account                                            Debit                                      Credit

FICA Tax Payable (Employee)        61.20

Federal Income Tax Payable          60.00

State Income Tax Payable              20.00

Cash                                                                                                             141.20

 

Notice that all the debits and credits are equal in all the three journal entries.

 



The Difference between Payroll Tax and Income Tax

When you are the employer of a business, it is your responsibility to withhold tax to your employees. A tax by definition is a compulsory contribution to state revenue, levied by the government on workers’ income and business profits or added to the cost of some goods, services and transactions. It is usually paid in the form of monetary contribution. Taxes are mostly used to fund government projects for the benefit of the public. Employment taxes are computed based on the salaries and wages of employees and are further classified into two: payroll tax and income tax. Most of the time, people use these terms interchangeably, but they have different meanings.

Employment Taxes Missing Deadlines

What is a Payroll Tax?

A payroll tax is a tax that consists of Social Security and Medicare taxes, collectively known as Federal Insurance Contributions Act (FICA). This tax is a shared kind of tax between the employer and employee, meaning both parties contributes their share to it.

A payroll tax is a certain percentage of the employee’s wages. It is computed at 7.65%. As mentioned earlier, this is an employer-employee tax. You withheld 7.65% from your employees’ wages and you also contribute 7.65%.

To further illustrate, assuming you have an employee who earns $800 per pay check. To compute for the payroll tax, you need to withhold $61.20 ($800 x 7.65%) from his salary. In the same way, you will contribute $61.20.

Payroll taxes consist of Social Security and Medicare Taxes. Social security is computed at 6.2%. The good thing about this is Social security has a wage base limit so you only need to withhold up to a certain amount. The wage base limit for 2018 is set at $128,400. Medicare portion is the remaining 1.45%. If social security has a wage base limit, Medicare portion has none. Instead there is a thing called Additional Medicare tax depending on the status of your employee and his income. Additional Medicare tax is 0.9%. You do not need to contribute for this since you do not owe the Additional Medicare tax.

If you are wondering what the purpose of payroll tax is, this tax is used to fund the Social Security and Medicare programs. Some of these include retirement, hospital care, disability, and survivor of deceased worker benefits. This tax commonly provides security for the employee upon his retirement or from any untoward accidents.

What is an Income Tax?

An income tax refers to federal, state and local income taxes. Unlike payroll tax, this tax is not one flat rate. Federal income tax depends on your employees’ withholding allowances. The more the employee claims, the less you withhold for the federal income tax. Federal income tax is supported by the Form W-4 or the Employee’s Withholding Allowance Certificate. To compute for the amount of the federal income tax, you can refer to IRS Publication 15.

State income tax is quite similar to federal income tax. Employees can also claim allowances from state income tax. This is supported by a state income tax withholding form. You might also need to pay for local income taxes depending on the location of your business.

While payroll taxes are used to fund the social and health care benefits of employees, income taxes are used to fund public services like defense, transportation and education. This tax benefits the general public.

Similarities

After withholding taxes, you are required to file and report them to the Internal Revenue Service (IRS). Your schedule of deposit for both taxes is the same. You will also use the same form to report them (Form 941 or Form 944). It is only important to remember that federal income taxes and payroll income taxes have separate lines in the reporting form.

Both of these taxes are withheld from your employees’ pay checks. As an employer, you should provide your employees pay slips where in the details of all their salaries and wages are shown. The pay slips should also contain the taxes and all other deductions withheld from them. You need to do this to show transparency to your employees that correct amount of salaries and wages are given and proper taxes are withheld.



The Importance of Payroll in Business

Signed up payroll

Companies pay their employees through monthly wages. Employees need to be able to rely on being paid on a consistent basis without delays.

A payroll is the sum total of all compensation a business must pay to its employees for a set period of time or on a given date. It is an integral part of all organizations. Oftentimes, many people view the payroll as a merely processing function. It plays a vital role in protecting the company’s reputation by ensuring the correctness of all the data in the system and ensuring compliance with regulating authorities.

How does Payroll affect an Organization?

  1. Morale of Employees

An important aspect of payroll is its effect on the morale of the employees. Employees need assurance that they will be paid on time regardless of any situation. If not, they will start questioning the financial integrity of the company. This is more evident in small business rather than in large scale businesses. If employees are not paid on time, they might compromise on the work climate within the organization which can result to under performance of their jobs. Payroll should always be paid in a timely manner to keep the morale of employees high.

 

  1. Compensation to Employees

The second important characteristic of payroll is the compensation package it gives to the employees. Employees feel their net worth in the company through the payroll. It is the means by which they feed themselves and their loved ones at home. The payroll contains all the salaries, incentives, allowances and other form of benefits they receive. Companies also provide health insurances and other bonuses. Yearly evaluation is also done to promote deserving employees thus giving him a raise in his pay. Employees will feel more important if they receive complete compensation package from the company.

 

  1. Elevating the Company’s Reputation

Providing payroll to its employees is not just the obligation of the organization but it must also adhere to tax rules and regulations. The payroll department of every organization must ensure that its payroll activities are in conformity with the state rules and comply with employment legislations. Tax obligations must be submitted on time to avoid inconvenience to the company. An accurate payroll will help the reputation of the company. It will establish the organization’s reputation as a stable employer. This can really help in attracting more talented employees and keeping the good employees you already have.

 

  1. Lower Tax Bills

The last important aspect of payroll is its effect in tax bills. It needs to be done right to lower state and federal taxes. This is in particular with small businesses. Owners should make sure that they withheld the proper amount of taxes each year from the payroll.

A payroll is an integral part of the operations in any organization. It needs to be precise and free from any errors. A good company provides the correct payroll to its employees. When you are a good and responsible payroll provider, your employees will help your business to prosper.



The Need for Payroll Training

Employee Entry Database

Do you work in a payroll department? Do you think there is a need for payroll training in your organization?

Payroll contains all the information and all the wages of the employees. Since payroll is an important process in any organization, proper training is also needed to keep the company updated in any latest payroll methods. Payroll training is something which should be given to those working in the payroll department. Payroll training courses can give your company more efficiency in preparing your payroll reports.

Payroll training is important for the reason that it will give you and your staff a clear perceptive of how actual payroll works. If you have a new hire in the payroll department, there is a need for payroll training. It can also help your other employees to have a refresher course. Payroll training can give you the latest payroll methods. Excellent payroll training should not only help prepare you and your business for the day to day payroll activities, but it should also provide you with the sufficient knowledge to help deal with any minor payroll issues. If you have a payroll system in your company, having a proper training will help you use the software more efficiently. Trainings for troubleshooting are also provided should a payroll issue occurs and how to prevent them. Lastly, payroll training can help uplift the confidence of your employees. Employees are happy when they learn new things at work. They can perform better in their jobs because the company gives them the trainings they need.

Payroll employees need to be given the proper training once in a while. Calculating all employees’ salaries and benefits is not an easy job. Motivating them through training can result to more accurate payroll reports which you can use in improving your business.



Payroll System for Small Businesses

Professional Payroll Company

Providing for the employees’ payroll is the responsibility of a good employer. Businesses have different number of employees. Large scale businesses need a large number of employees while small businesses need only a few. Employees are usually the largest expenses in a company. Their wages are just one part of the payroll. Companies provide allowances, incentives, commissions, health insurances, bonuses and other benefits to their employees. Managing and maintaining all the data of the employees is quite a task for anybody to handle in an organization. It is a time consuming job which can be prevented if the company decides to use a payroll system.

What is a Payroll System?

A payroll system is an important software program that calculates payroll accurately in compliance with state laws and taxes.

Small businesses usually run their payroll systems similar to larger organizations. Using a payroll system for a small business can lessen the job of the person handling it. The system is designed for easy access and is simple to use. Some payroll systems are also affordable so that even small businesses may afford it. The use of payroll software is an efficient way of calculating pays than a manual system. It simplifies the information and generates reports to minimize errors.

If an organization relies on a manual system for its payroll, the data can be prone to errors. Due to a human’s limited capacity, it can be a cause of inaccuracy to a company’s payroll system. When the generated reports contain errors and are submitted to governing authorities, it can affect the reputation of an organization.

Characteristics of a Good Payroll System

Small business payroll software solutions have significant user friendly features and provide fast and accurate payroll result. Some of the important characteristics of a good payroll system are the following:

  1. It can handle multi company transactions
  2. It gives accurate computation
  3. It can compute bonuses, commissions, incentives and other benefits
  4. It can calculate monthly salaries
  5. It can withheld proper taxes
  6. It can generate management and operation reports
  7. It can handle all employees’ profiles
  8. It can provide a detailed payroll report

The payroll software for small businesses has a simple interface because it is developed keeping in mind the common user. It has no complicated parameters and options. It is important to use fast and easy to use software to ensure the correctness of the payroll. Also, an accurate payroll system can help the decision making of the Human Resource Department.

There are a lot of companies providing payroll software solution all over the world. It is important to choose a reputable service provider that offers quality and reliable software solutions. You can consult them for suggestions. Choose the best software solutions for your business needs.

A payroll system is vital for any business. With today’s technology, payroll software solutions can give you a high percentage of accuracy. Preventing errors from the payroll reports will benefit your business in many ways.



Common Payroll Mistakes

It is the responsibility of every business to compute the payroll of its employees. And by computing, it means the correct calculation of the payroll. If you commit mistakes in calculating the payroll of your employees, this can be quite inconvenient for you and your business. An incorrect payroll may result to loss of trust of your employees. It will also result to payment of fines to the government since wrong taxes were remitted to them. It is important to compute for the correct amount of payroll for transparency purposes.

Status in profiles

Below are some common payroll mistakes that you should avoid in computing your employees’ payroll.

  1. Classifying workers improperly

There are two kinds of workers in a company: the contractors and employees. Mixing up the two can be a costly mistake for you and your business. You don’t pay benefits for contractors. You don’t withhold tax in their behalf. Meanwhile, employees are entitled to their monetary benefits and you are required to withhold tax from their pay checks. If you misclassify a worker, you will have to pay both the employee and employer’s share of taxes plus penalties and interest. You might also owe back wages to the employee.

  1. Classifying exempt employees improperly

You also need to remember that there are two classifications of employees in a company: the exempt and the non-exempt. In the case of exempt employees, you do not pay overtime wages to them. It is different for your non-exempt employees. You are required to pay overtime wages to them should they work beyond 40 hours in a work week. If you mistakenly classify an employee as exempt from overtime wages, they could miss out on wages. As a result, you’ll owe them back wages. Make sure to check your state laws as some states might have different laws about who can be exempt.

  1. Miscalculating overtime wages

Overtime wages are additional wages you pay for your employees in excess of the normal working hours they render. Usually, an employee has to work 40 hours per week. If he works beyond that, he is entitled for an overtime pay. If you do not pay the correct overtime rate, you might owe back wages, penalties and interest. The FLSA states that you must pay employees 1.5 times their regular rate of pay for any time worked beyond 40 hours in a week. You might also need to check the rules of your state regarding overtime pay as some states might have different overtime wage laws.

  1. Running payroll late

It is very important to pay your employees in a designated pay frequency. Your employees rely on their wages for their living. They are expecting to receive their wages on a regular basis. If not, this can destroy their trust in you and can result in low performance of their jobs. Pick a regular pay frequency for your employees and stick to it. You can pay them weekly, biweekly, semi-monthly or monthly.

  1. Paying the wrong tax rates

This is an important compliance to your state laws. Paying the wrong amount of tax can result to penalties and interest to your business. Tax rates may change all the time so you need to make sure that you regularly check them. This will avoid any inconvenience in your part.

Avoiding these common payroll mistakes can benefit you and your employees. It will create a harmonious relationship between you, your employees and the government.



How to Calculate for FICA Taxes

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The Federal Insurance Contributions Act or FICA is part of the payroll taxes that you should pay the government should you own a business. This tax is used to fund the social security benefits and Medicare benefits of employees which they can use upon retirement or any untoward accidents at work.

FICA taxes are further broken down into two:

  • Social Security
  • Medicare

Social security is a portion of FICA tax and is set at 6.2% for the year 2018 for wages paid up to $128,400. After reaching the wage base limit, you need to stop withholding the Social Security tax rate. If you accidentally withhold Social Security tax past the wage base limit, you need to refund your employees. Social security tax is shared by the employer and the employee. Therefore, total remittance should be 12.4%.

Medicare tax on the other hand has no wage base limit and is set at 1.45%. Instead, it has a thing called Additional Medicare tax applied to employees who earn above $200,000. If an employee is single and is paid over $200,000, you must withhold an additional 0.9% of their wages in addition to the 1.45%. If you have an employee who is married and filing jointly, the additional Medicare tax applies to income over $250,000 while if he is married filing separately, additional Medicare tax applies to income over $125,000. Employers are only required to contribute to the 1.45% standard and not to the Additional Medicare tax.

To further illustrate, let’s say you have an employee who is earning $1,000 per pay check. To know how much social security tax you need to withheld, you must multiply his gross wages to 6.2%. In this case, $1,000 x 6.2%= $62.00. You also need to contribute $62.00 as an employer.

For the Medicare tax portion, you need to withheld $14.50 ($1,000 x 1.45%) from your employee’s pay check and you need to contribute the same amount.

Computing for FICA taxes is quite easy if you follow the rules governing them.

 



1099 Worker vs. W-2 Employee

the difference w2 employees and 1099 independent contractors

One good benefit of a business to an economy is its ability to provide jobs to many people. Businesses hire workers to perform specific tasks for them, either to sell their goods or to render service. In return, they earn salaries which they use to improve their living. The amount they earn depends on the work they perform or the duration of the job given to them.

There are two kinds of workers that a business may employ: a contractor and an employee. How is a contractor different from an employee and vice versa? Do they have similarities as well?

Who is a Contractor?

A contractor is a company or a person that undertakes a contract to provide materials or labor to perform a service or do a job. In today’s economy, many businesses are trying to cut back on full time employees to save on expensive benefits. This can be done by hiring a contractor. A contractor can perform the same job with a fixed payment called the contract price.

A contractor uses the 1099 form for tax purposes. If you are a contractor, you are responsible in computing your own payroll taxes and remitting the same to the government on a quarterly basis.

Who is an Employee?

An employee on the other hand is an individual who works part-time or full-time under a contract of employment, whether oral or written, express or implied, and has recognized rights and duties. Employees are entitled not only of salaries and wages but also other benefits. These benefits include health care insurance, retirement benefits and other allowances.

An employee uses the W-2 form for tax purposes. If you are an employee, payroll taxes are automatically deducted from your pay check and are remitted to the government through your employer.

How to Determine a Contractor and an Employee

To identify who is the 1099 worker and who is the W-2 employee, you must know who control the work they do.

You are an independent contractor if you perform the following:

  • Set your own schedule
  • Use your own strategies to finish your assigned job.
  • Accept task anytime or turn down offers of work
  • Supply your own materials, tools and equipment
  • Supply your own labor
  • Have more than one client

On the other hand, you are considered as an employee if you perform the following:

  • Have fixed hours or set schedule of work
  • Get trainings by the company to perform your job more efficiently
  • Complete all the tasks assigned by your immediate superior
  • You are provided by the materials and tools you need to do your job
  • Have only one employer

It is important to know your classification to be able to fill up the proper form and remit the correct amount of tax. This will not also create confusion to the company.

Both the contractor and employee help the business. Whatever you choose to become, remember to be a responsible citizen and pay the correct amount of tax due.

 



Basics Principles of Payroll Taxes

Computing for payroll taxes can be quite a workload especially if you are not familiar with the governing rules of payroll in your state. One of these rules is paying the correct amount of payroll taxes.

Payroll taxes are shared taxes which are shouldered by the employer and the employee through the payroll process. That is, these taxes are taken out of (withheld from) employee pay, are collected by employers and paid by employers on behalf of employees and themselves.

Money and Time

What do Payroll Taxes pay for?

The federal government levies payroll taxes on wages to fund Social Security, Medicare and other social insurance benefits. Federal income taxes also go towards things like defense and security.

State income taxes go towards a variety of areas such as education and health care, as well as transportation, state police, parks and recreation.

Kinds of Payroll Taxes

U.S payroll taxes include:

  • Federal income tax withholding (FIT)

These are taxes withheld from employee pay and are owed by the employees. The amount of FIT is determined based on the information provided in the Form W-4 upon employee hiring.

  • Taxes paid for Social Security and Medicare (FICA)

Federal Insurance Contributions Act requires payment of taxes to be used for social security and Medicare. Employers and employees share this tax, with the employer deducting the employee share (one-half of the total due) from employee wages/salaries and the employer paying the other half. For the year 2018, social security taxes are set at 6.2% and Medicare tax rates are set at 1.45% on the first $200,000 of wages and 2.35% for wages above $200,000.

How do you process payroll taxes?

Payroll taxes are based on the employee’s gross pay. An employee earns his gross pay after a certain period. From there, the employer deducts a specific amount for federal income tax which is based on the W-4 Form of the employee. Afterwards, he will deduct a specific amount for FICA taxes.

How do employers pay payroll taxes?

The payroll tax process is quite a task. It involves several steps. After deducting the calculated amounts for federal income tax and FICA tax, an employer must report and pay these to the government.

  • After completing the payroll process, you must pay for FICA taxes and federal income taxes as a whole business.
  • Remit the payments to the IRS either monthly or semi-weekly based on the size of your total employee payroll
  • The proper form for reporting payroll taxes quarterly is the Form 941.
Can employers pay payroll taxes online?

An employer after completing the payroll process and computed the amount due for payroll taxes, may choose to pay online using the Electronic Federal Tax Payment System (EFTPS). State agencies will generally have their own electronic or manual processes to submit payroll taxes.

Payroll taxes are due to the government. If not paid correctly and on time, your business may suffer from penalties and late charges and accrue interest. If you are not confident enough to process the payroll in your business, hiring a payroll service may take care of the payroll process of your business.



How to Deal with Incorrect Employee Withholding

Record Keeping, Data Collection Weekly Time Sheet

Withholding taxes are part of the payroll process. They are one of the deductions made to the pay check of your employees aside from the usual FICA taxes and other state taxes. But what happens if you incorrectly compute the withholding tax of your employees?

Two things can happen. It’s either you under withheld or you over withheld the tax of your employees. All businesses are required to file the Form 941 quarterly to the IRS.

It is not hard to miscalculate employee withholding tax especially if you are not using payroll software. If you under withheld, you can catch up the missed withholding amounts in the months ahead by withholding additional from the employee’s check until the under-withholding has been corrected.

If taxes have been over withheld, you can make a correction in future pay periods by withholding less than the amount calculated on the tables or charts. You can let the withholding stand as is. Over-withheld income tax will correct itself when the employee files a tax return.

You need to ensure correct computation of your employees’ tax to avoid inconvenience and returning wages you owe to them or your employees owing money to you. This can cause additional workload to your payroll department.

Having a payroll software installed in your payroll department can help you compute for the correct amount of taxes and prevent miscomputing of withholding tax due from your employees. It will also lessen the work of your payroll officer.

 




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