Payroll Taxes Payable Liabilities for payroll taxes result from companies employing people. Employers are responsible not only for paying their employees, but also for complying with payroll tax laws. For example, one important requirement of payroll tax laws is employers must withhold income taxes from employees' pay. To better understand many issues related to payroll taxes liabilities, the following paragraphs briefly examine some major issues of payroll systems.

Payroll systems In general, payroll refers to the dollar amounts earned by employees for services they provide to companies. Payroll is often the largest expense of service businesses, such as legal firms, accounting firms, and consulting companies. Payroll is often the second largest expense of merchandising and manufacturing companies, second only to the cost of goods sold. Payroll systems accumulate data and use them to calculate the dollar amount due each employee, the amounts owed to governments and other agencies, and the company's payroll-related expenses and liabilities.

Employee earnings An employee's total earnings for a given period is called gross pay. An employee's gross pay depends upon the contract between the employee and employer. Some employees' earnings are based on the number of hours they work. Their gross pay, often called wages, is calculated by multiplying the number of hours worked by their pay rates per hour. For example, an employee who worked 30 hours in a week at a wage rate of $8 per hour would have earned wages of $240 for the week ($30 hours x $8 per hour). Other employees' earnings are not based on the number of hours they work but, rather, on a longer period of time, such as a week or month. Their gross pay, often called salaries, is simply their salary for the period. For example, an employee whose monthly salary is $4,000 would have earned a salary of $4,000 during a month. Hourly employees usually receive 11/2 times their normal wage rates if they work in excess of a certain number of hours in a week, such as 35 or 40. Depending on the employer and employee, salary employees also may receive such overtime premiums. Since gross pay is an employee's total earnings for a period, it would include any overtime premium earned by the employee.
 

Practice Exercise

Scott Sullivan's employment contract requires him to work 40 hours per week at a wage rate of $12 per hour. If he works more than 40 hours in a week, his will earn 11/2 times his normal wage rate. Calculate Scott's gross pay for a week in which he works 48 hours.
 

Hours

Wage Rate per Hour

Gross Pay

First 40 hours

$12

$480 (40 hours x $12)

8 overtime hours

$18 ($12 x 1.5)

$144 (8 hours x $18)

Total gross pay

 

$624

** You now have the background to do text exercise 10.11.
 

Deductions For many reasons, employers do not pay employees their actual gross pay. Federal and state laws require employers to keep, or withhold, taxes from employees' gross pay and pay the taxes directly to the governments. Some employees instruct their employers to withhold amounts for insurance, savings, and union dues. Dollar amounts withheld from employees' gross pay are called payroll deductions. If you ever worked for an employer, you know that because of payroll deductions your gross pay virtually never equals the amount of pay you take home. Some of the largest payroll deductions are briefly discussed below.

Employee federal income taxes In most cases, the largest dollar amounts withheld from employees' gross pay are for employee federal income taxes. As mentioned earlier in the discussion of sales taxes, companies sometimes act as collection agents for governments. Such is the case with employees' federal income taxes. Employers are required to withhold the proper amount of federal income taxes from employees and to pay such tax amounts to the federal government. Periodically the federal government will provide employers with information they will need in order to determine the proper amount of income taxes to withhold from each employee's gross pay. The federal government also provides employers with instructions about when they must pay the government the income taxes withheld from employees.

Employee state income taxes Many states also require employers to withhold state income taxes from employees' gross pay. Once again, companies act as collection agents for governments. Periodically state governments provide employers with information for determining the proper amount of income taxes to withhold from each employee's gross pay and when they must pay the state governments the income taxes withheld.

Employee FICA taxes Since 1937 the federal government has been funding the federal social security program partially through employee payroll deductions. Employers are required to withhold amounts from employees' gross pay and pay the amounts to the federal government. The social security program was created through the Federal Insurance Contributions Act and the taxes are usually referred to as FICA taxes. There are two separate FICA taxes: OASDI and Medicare.

One part, the traditional part of FICA taxes, provides old age, survivors, and disability insurance to qualified individuals and is referred to in the following discussion as the FICA OASDI tax. Employers are required to withhold 6.2% of the first $97,500 of each employee's gross pay for the year 2007. For example, consider the following three employees.

Employee #1 had gross pay of $900 for the current week. Prior to this week, employee #1 had earned $30,000 in 2007. Calculate the FICA OASDI taxes withheld from employee #1's $900 gross pay this week.

FICA OASDI taxes = $900 x .062 = $55.80. Since employee #1's gross pay for the year, prior to this week, totaled $30,000, the full $900 of this week's gross pay is subject to FICA OASDI taxes.

Employee #2 had gross pay of $900 for the current week. Prior to this week, employee #2 had earned $97,300 in 2007. Calculate the FICA OASDI taxes withheld from employee #2's $900 gross pay this week.

FICA OASDI taxes = $200 x .062 = $12.40. Since employee #2's gross pay for the year, prior to this week, totaled $97,300, only $200 could possibly be subject to FICA OASDI taxes this week ($97,500 maximum - $97,300 gross pay prior to this week). Since employee #2 earned $900 this week, only $200 of this week's gross pay is subject to FICA OASDI taxes.

Employee #3 had gross pay of $900 for the current week. Prior to this week, employee #3 had earned $98,000 in 2007. Calculate the FICA OASDI taxes withheld from employee #3's $900 gross pay this week.

FICA OASDI taxes = $0 x .062 = $0. Since employee #3's gross pay for the year, prior to this week, totaled $98,000, the employee had already reached the maximum taxable gross pay prior to this week. Thus, none of this week's gross pay of employee #3 is subject to FICA OASDI taxes. Furthermore, none of employee #3's gross pay for the rest of 2007 will be subject to FICA OASDI taxes.
 

The second part of FICA taxes provides health and hospital insurance to qualified individuals and is referred to in the following discussion as the FICA Medicare tax. Employers are required to withhold 1.45% of each employee's gross pay for the year 2007. For example, consider the following three employees.

Employee #1 had gross pay of $900 for the current week. Prior to this week, employee #1 had earned $30,000 in 2007. Calculate the FICA Medicare taxes withheld from employee #1's $900 gross pay this week.

FICA Medicare taxes = $900 x .0145 = $13.05. Since there is no limit on the amount of gross pay subject to FICA Medicare taxes, the full $900 of this week's gross pay is subject to FICA Medicare taxes.

Employee #2 had gross pay of $900 for the current week. Prior to this week, employee #2 had earned $97,300 in 2007. Calculate the FICA Medicare taxes withheld from employee #2's $900 gross pay this week.

FICA Medicare taxes = $900 x .0145 = $13.05. Since there is no limit on the amount of gross pay subject to FICA Medicare taxes, the full $900 of this week's gross pay is subject to FICA Medicare taxes.

Employee #3 had gross pay of $900 for the current week. Prior to this week, employee #3 had earned $98,000 in 2007. Calculate the FICA Medicare taxes withheld from employee #3's $900 gross pay this week.

FICA Medicare taxes = $900 x .0145 = $13.05. Since there is no limit on the amount of gross pay subject to FICA Medicare taxes, the full $900 of this week's gross pay is subject to FICA Medicare taxes.
 

Practice Exercise

The FICA OASDI taxes rate for 2007 is 6.2% of the first $97,500 of each employee's gross pay for the year. The FICA Medicare taxes rate for 2007 is 1.45% of each employee's total gross pay for the year. For the week ended October 31, 2007, Scott Sullivan's gross pay was $624.

1. Assume prior to the week ended October 31 Scott's gross pay for 2007 was $18,000. Calculate the total FICA taxes withheld from Scott's $624 October 31 wages.

The maximum taxable income for FICA OASDI purposes is $97,500 in 2007. Since Scott's gross pay for the year is well below this maximum, the full $624 of gross pay for the week is taxable. Thus, he would have $38.69 ($624 x .062) withheld from his gross pay for FICA OASDI taxes.

Since there is no maximum income limit for FICA Medicare taxes, the full $624 of gross pay for the week is taxable. Thus, he would have $9.05 ($624 x .0145) withheld from his gross pay for FICA Medicare taxes.

The total FICA taxes withheld from Scott's October 31 wages would be $47.74 ($38.69 OASDI + $9.05 Medicare).

2. Assume prior to the week ended October 31 Scott's gross pay for 2007 was $97,200. Calculate the total FICA taxes withheld from Scott's $624 October 31 wages.

The maximum taxable income for FICA OASDI purposes is $97,500 in 2007. Since Scott's gross pay for the year was $97,200 prior to this week, the maximum income that could possibly be taxed this week is $300 ($97,500 - $97,200).   Since Scott earned over $300 this week, only $300 of gross pay for the week is taxable. Thus, he would have $18.60 ($300 x .062) withheld from his gross pay for FICA OASDI taxes.

Since there is no maximum income limit for FICA Medicare taxes, the full $624 of gross pay for the week is taxable. Thus, he would have $9.05 ($624 x .0145) withheld from his gross pay for FICA Medicare taxes.

The total FICA taxes withheld from Scott's October 31 wages would be $27.65 ($18.60 OASDI + $9.05 Medicare).
 

** You now have the background to do text exercise 10.12.
 

Other deductions In addition to federal income taxes, state income taxes, and FICA taxes, employees often have employers withhold for other purposes, such as city income taxes, union dues, insurance, savings, retirement, and contributions.

Net pay The payroll dollar amount an employee actually receives from employers is called net pay. Net pay is equal to gross pay less deductions. Each employee's net pay for a given pay period, along with gross pay and deductions, is reported in the payroll register. A simple example of the Nicholas Corporation's payroll register for the week ending August 12 appears below.
 

Employee

Gross
Pay

Federal
Income
Taxes

State
Income
Taxes

FICA
OASDI

FICA
Medicare

Union
Dues

Net
Pay

1034

800.00

160.00

40.00

49.60

11.60

5.00

533.80

1057

1,300.00

280.00

65.00

80.60

18.85

5.00

850.55

Totals

2,100.00

440.00

105.00

130.20

30.45

10.00

1,384.35

The payroll register shows the company's employees will be paid $1,384.35 for the week, even though they had earned a total of $2,100.00. The employees' net pay differed from their gross pay because of deductions for federal income taxes, state income taxes, FICA taxes, and union dues. The company will pay $1,384.35 to employees and the amounts deducted from their gross pay will be paid to other entities, such as the federal and state governments.

The information in the payroll register is used to record payroll in the company's accounting system.

Show the effects on the company's resources and sources of resources of the August 12 payroll.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

 

 

+ $2,100

 

 

+

- $2,100 

The company's resources (assets) do not change because the company does not pay the net pay or the amounts deducted until the dates specified by the employees' contracts, government schedules, or union agreements. The company's liabilities increase because $2,100 is owed to the employees, governments, and the union. The $2,100 owed is a current liability because it will be paid within the next 12 months. The company's stockholders' equity decreases by $2,100, the company's cost of employees' services used up by management in the week ended August 12.

Remembering that assets increase with debits and debits equal credits, prepare the journal entry to record the August 12 payroll.
 

Date

Description

Post.
Ref.

Debits

Credits

Aug. 12

Salaries and Wages Expense

 

2,100.00

 

 

     Employees' Federal Inc. Tax. Payable

 

 

440.00

 

     Employees' State Inc. Tax. Payable

 

 

105.00

 

     FICA Taxes Payable

 

 

160.65

 

     Employees' Union Dues Payable

 

 

10.00

 

     Salaries and Wages Payable

 

 

1,384.35

 

August 12 payroll

 

 

 

The employees' total gross pay is recorded as the company's salaries and wages expense because it is the total amount of employees' services used up by the company. The company must pay the full $2,100, some goes to employees, some to governments, and some to the union. Liabilities are recorded for the amounts withheld from employees' gross pay and for the net pay owed employees. Several liability accounts include the word "employees" to distinguish them from other liabilities. For example, the liability for federal income taxes withheld from employees is recorded in an employees' federal income taxes payable account, while the liability for the company's federal income taxes on its taxable income is recorded in a federal income taxes payable account. Finally, in the above journal entry, FICA taxes payable includes OASDI and Medicare taxes withheld. These two tax amounts are often combined into one account because they are both FICA taxes and are paid to the federal government at the same time.
 

** You now have the background to do text exercise 10.13 and 10.14.

 

 

Previous section

Next section