Payroll Withholdings: Taxes & Benefits Paid By Employees
This section of payroll accounting focuses on the amounts withheld from employees' gross pay. (Later we will discuss the payroll taxes that are not withheld from employees' gross pay.)
The U. S. income tax system and many state income tax systems require employers to withhold payroll taxes from their employees' gross salaries, wages, bonuses, etc. The withholding of taxes and other deductions from employees' paychecks affects the employer in several ways:
- The amount paid to employees on payday is reduced
- The employer must record a current liability in its accounting records for the amount withheld
- The employer must remit the withheld amounts by the required dates
Failure to remit the payroll taxes by their due dates can result in severe penalties.
The withholdings from an employee's gross pay include:
- Employee portion of Social Security tax
- Employee portion of Medicare tax
- Federal income tax
- State income tax
- Court-ordered withholdings
- Other withholdings
1. Employee portion of Social Security tax
A key component of payroll accounting is the Social Security tax which along with the Medicare tax make up what is referred to as FICA. Social Security tax is withheld from an employee's salary or wages and the employer is also required to pay a Social Security tax. In other words, the employer is responsible for remitting to the federal government both the employee and the employer portions of the Social Security tax.
In 2023, the amount of Social Security tax that an employer must withhold from an employee is 6.2% of the first $160,200 of the employee's annual wages and salary; any amount above $160,200 is not subject to Social Security tax withholdings. The $160,200 is referred to as the Social Security wage base, wage limit, ceiling or maximum taxable earnings. For example:
If an employee earns $40,000 in wages in 2023, the entire $40,000 is subject to withholdings at 6.2%, for a total annual withholding of $2,480.
If an employee earns $200,000 in salary in 2023, only the first $160,200 of the salary is subject to the Social Security tax of 6.2%, for a total annual withholding of $9,932.40. (The amount of salary that is greater than $160,200 is not subject to Social Security tax withholdings, although it will be subject to the Medicare tax discussed in the next section.)
The amount withheld—and the employer's portion—are reported as a current liability until the amounts are remitted to the government by the employer.
NOTE: The employee's tax rate for Social Security and the amount subject to the tax can be found in the IRS Publication 15, Employer's Tax Guide.
2. Employee portion of Medicare tax
Medicare tax is also withheld from an employee's salary or wages and the employer is also required to pay a Medicare tax. In other words, similar to the Social Security tax the employer is responsible for remitting to the federal government both the employee and the employer portions of the Medicare tax. (The Medicare program helps pay for hospital care, nursing care, and doctor's fees for people age 65 and older as well as for some individuals receiving Social Security disability benefits.)
(The combination of the Social Security tax and the Medicare tax is referred to as FICA tax, or the Federal Insurance Contribution Act tax.)
An employer must withhold 1.45% of each employee's annual wages and salary for the Medicare tax. Unlike the Social Security tax, this percentage is applied on every employee's total wages or salary no matter how large the amount might be—an employee's salary of $200,000 will require Medicare tax withholdings of $2,900 (the entire $200,000 times 1.45%).
Also, there is a Medicare surtax of 0.9% (which is also known as the Additional Medicare Tax) that is withheld from the employee on wages and salaries that are in excess of $200,000 in a calendar year. However, this Additional Medicare Tax is not matched by the employer. See IRS Publication 15, Employer's Tax Guide for more information on this additional tax.
The employee's Medicare tax and Additional Medicare Tax withholdings plus the employer's Medicare tax are reported as a current liability until the amounts are remitted to the government by the employer.
3. Federal income tax
The amount withheld for federal income tax is based on the employee's salary or wages as well as personal information (including whether to be taxed at the Single or Married income tax rates) that the employee is required to provide the employer on IRS Form W–4, Employees Withholding Allowance Certificate.
In cases where an employee is paid low wages, it may not be necessary for the employer to withhold any federal income tax. Unlike FICA, there is no employer contribution for federal income tax.
Amounts withheld from employees for federal income taxes are reported on the employer's balance sheet as a current liability. When the employer remits the amounts to the federal government, the current liability is reduced.
Federal income tax withholding methods and tables are included in IRS Publication 15 and Publication 15-A.
4. State income tax
In most states payroll accounting will involve a state income tax. In those states an employer is required to withhold the state income tax that an employee is expected to owe based on salaries or wages. Like its federal counterpart, the amount withheld is rarely the exact amount of income tax that the employee will owe to the state government. (Some states do not have a personal income tax.)
The amount withheld for state income tax is based on the employee's salary or wages as well as personal information that the employee is required to provide the employer on a state version of Form W–4.
In cases where an employee is paid low wages and/or has a large number of personal exemptions, it may not be necessary for the employer to withhold any state income tax.
Amounts withheld from employees for state income taxes are also reported on the employer's balance sheet as a current liability. When the employer remits the amounts to the state government, the current liability is reduced.
5. Court-ordered withholdings
Payroll accounting also involves withholdings for items other than payroll taxes. For example, courts of law may order employers to garnish (withhold money from) an employee's salary or wages for purposes such as paying child support or repaying debts.
The amounts withheld from employees for court-ordered withholdings are reported on the employer's balance sheet as a current liability. When the employer remits the amounts to the designated parties, the liability is reduced.
Some court orders may include a small fee to be withheld from the employee in order to reimburse the employer for administrative expenses. For example, the court order might direct the employer to withhold $101 from the employee and to remit $100 to a designated agency. The $1 difference will be a credit to the company's administrative expenses or to a miscellaneous revenue account.
6. Other withholdings
In addition to the mandatory withholdings that an employer makes for taxes and court orders, payroll accounting often includes amounts that employers may be willing to withhold at the direction of its employees. These voluntary withholdings can include such things as:
- Union dues
- Charitable donations
- Insurance premiums
- 401(k) and 403(b) contributions
- U.S. Savings bonds purchases
- Payments owed to the company for the purchase of company merchandise
If the voluntary withholdings are to be remitted to places outside of the company (a local charity, for example), the amounts withheld are reported on the employer's balance sheet as a current liability. When the employer remits the withholdings, the current liability is reduced.
If the withholdings are for amounts that are due the company (such as employees' share of insurance premiums or amounts owed by employees for company merchandise), no remittance is required. Rather, the journal entry reflects a credit that reduces the company's insurance expense or reduces the company's receivables from employees. Sample journal entries are provided later in this topic.
NOTE #1: Some payroll deductions/withholdings will reduce the employee's taxable gross wages thereby reducing the amount of taxes withheld from the employee's paycheck. These are referred to as pre-tax deductions.
Other payroll deductions/withholdings do not reduce the employee's taxable wages and therefore will not reduce the amount of taxes withheld from the employee's paycheck. These are referred to as post-tax deductions.
You should consult with your tax advisor to learn more about pre-tax and post-tax deductions.
NOTE #2: A few states require employees to contribute a minimal amount toward the state unemployment insurance. However, the employers typically contribute the entire amount.
Net pay is the amount that remains after withholdings are deducted from an employee's gross pay. Net pay is also referred to as "take home pay" or the amount that an employee "clears." From the company side of the transaction, it is the cash amount that the company will pay directly to the employees on payday. (The cash amount may be in the form of a check, a direct deposit, or other.)