Payroll Taxes, Costs, and Benefits Paid By Employers
In addition to salaries and wages, the employer will incur some or all of the following payroll-related expenses:
- Employer portion of Social Security tax
- Employer portion of Medicare tax
- State unemployment tax
- Federal unemployment tax
- Worker compensation insurance
- Employer portion of insurance (health, dental, vision, life, disability)
- Employer paid holidays, vacations, and sick days
- Employer contributions toward 401(k), savings plans, & profit-sharing plans
- Employer contributions to pension plans
- Post-retirement health insurance
1. Employer portion of Social Security tax
In addition to the amount withheld from its employees for Social Security taxes, the employer must contribute/remit an additional amount, which is an expense for the employer. In the year 2023, the employer's portion of the Social Security tax is 6.2% of the first $160,200 of an employee's annual wages and salary. Hence, the employer's amount is referred to as the matching amount.
For example, if an employee earns $40,000 of wages, the entire $40,000 is subject to the Social Security tax. This means that in addition to the withholding of $2,480, the employer must also pay $2,480. The combined amount to be remitted to the federal government for this one employee is $4,960 ($2,480 of withholding plus the employer's portion of $2,480).
For an employee with an annual salary of $200,000 in the year 2023, only the first $160,200 is subject to the Social Security tax. This means that in addition to the withholding of $9,932.40, the employer must also pay $9,932.40. The combined amount to be remitted to the federal government for this one employee is $19,864.80 ($9,932.40 + $9,932.40).
The employer's share of Social Security taxes is recorded as an expense and as an additional current liability until the amounts are remitted.
2. Employer portion of Medicare tax
In addition to the employee's Medicare tax there is also an employer's Medicare tax. The employer's Medicare tax is considered to be an expense for the employer. For the year 2023, the employer's portion of the Medicare tax is the same rate as the employee's withholding—1.45% of every dollar of each employee's annual wages and salary.
Unlike the Social Security tax, the Medicare tax has no cap (ceiling or limit). For example, if an employee earns a salary of $200,000, the employer must pay a Medicare tax of $2,900 ($200,000 x 1.45%) in addition to the $2,900 that was withheld from the employee. The combined amount to be remitted to the federal government for this one employee is $5,800.
The employer's share of Medicare taxes is recorded as an expense and as an additional current liability until the amounts are remitted.
There is a Medicare surtax known as the Additional Medicare Tax which is withheld from employee's earnings in excess of $200,000. However, the employer does not match the Additional Medicare Tax.
3. State unemployment tax
State governments administer unemployment services (determine eligibility, remit payments to unemployed workers, etc.) and determine the state unemployment tax rate for each employer.
Generally, states require that the employers pay the entire unemployment tax rate. (Only a few states require employees to make a minimal contribution.)
The state unemployment tax rate is applied to each employee's wages up to the state unemployment wage base, which could be $7,000 per year in one state and $30,000 in another state.
If a state has an unemployment tax rate of 4% and an unemployment wage base of $14,000, it means that the employer's maximum payment for each employee will be $560 per year.
To illustrate, let's assume that a company has three employees. In the year 2023, Employee #1 earns $19,000, Employee #2 earns $40,000, and Employee #3 earns $4,000. If the 2023 state unemployment tax rate is 4%, the employer will pay a tax of $1,280 to the state government:
The contact information for each state's unemployment office is available at the following U.S. Department of Labor website: https://oui.doleta.gov/unemploy/agencies.asp
4. Federal unemployment tax
The federal government oversees the state unemployment programs and requires employers to pay a federal unemployment tax of 6.0% minus a credit if the employer has paid into a state unemployment fund and the state has met certain conditions. If an employer is allowed the maximum credit of 5.4%, then the federal unemployment tax rate will be 0.6%. This reduced rate is applied to each employee's first $7,000 of annual salaries and wages.
Using the example of three employees with annual 2023 earnings of $19,000, $40,000, and $4,000; with a federal unemployment tax rate of 0.6%, the employer will pay a tax of $108 to the federal government:
Even though the federal unemployment tax is based on employee salaries and wages, the entire tax is paid by the employer. There is no withholding from an employee's salary or wages for the federal unemployment tax.
The Federal Unemployment Tax Act (FUTA) requires employers to pay this tax. The employer is also required to file IRS Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return.
Additional information on FUTA can be found in IRS Publication 15, Employer's Tax Guide.
5. Worker compensation insurance
Worker compensation insurance (or workers' compensation insurance, or workers' comp) provides coverage for employees who are injured on the job. State law usually requires that employers carry this insurance. The cost of worker compensation insurance is a function of at least three variables: (1) the type of business or industry, (2) the type of job being performed, and (3) the employer's history of claims.
For example, statistics show that a production worker in a meat packing plant has a greater-than-average chance of suffering job-related cuts or back injuries. Because of this, worker compensation insurance rates for these employees can be as high as 15% of wages. On the other hand, the office staff of the meat packing plant—provided that they do not spend time in the production area—may have a rate that is less than 1% of salaries and wages.
The worker compensation insurance rates are applied to the wages and salaries of the employees to arrive at the worker compensation insurance premiums or costs. Although the insurance premiums are based on employee salaries and wages, generally the entire amount is paid by the employer and is considered an expense for the employer. (Contact your state's worker compensation office for the specifics in your state.)
If the employer pays the insurance premium in advance, a current asset such as Prepaid Insurance is used. The account balance will be reduced and Worker Compensation Insurance Expense will increase as the employees work.
If the employer does not pay the premiums in advance, the company must accrue the expense with an adjusting entry that increases Worker Compensation Insurance Expense along with increases in a current liability such as Worker Compensation Insurance Liability. In this situation the current liability will be reduced when the employer pays the worker compensation insurance premiums.
In some industries, worker compensation insurance is a significant expense for the employer and therefore we consider it an important part of payroll accounting.
6. Employer portion of insurance (health, dental, vision, life, disability)
In the past, many companies included group health, dental, vision, disability, and life insurance in the benefit package provided to employees. Over the past few decades, however, the costs for these group policies have risen significantly. Today the insurance premium for family coverage can be more than $10,000 per year per employee. As a result of these escalating costs, most companies now require employees to pay a portion of the premium cost; this amount is usually collected by means of employee-directed payroll withholding.
The employers' net cost (or expense) is simply the total amount of premiums paid to the insurance company minus the portion of the cost the employer collects from its employees.
7. Employer paid holidays, vacations, and sick days
Many companies pay their permanent employees for holidays such as New Year's Day, Memorial Day, July 4th, Labor Day, Thanksgiving, and Christmas. It is not unusual for employees to be paid for 10 holidays per year. It is also common for employees to earn one week of vacation after one year of service. Many employers give their employees two weeks of vacation after three years of service, with more weeks given after 10 years of service.
Paid sick days are also a common benefit given to employees. If an employee is absent from work due to such things as illness or surgery, the company will pay the employee for the time missed. Employers generally set policies as to how sick days are to be used, and as to whether or not an employee is permitted to carry over unused sick days into subsequent years.
The matching principle requires that the cost of compensated (or paid) absences (holidays, vacations, and sick days) be recognized as an expense during the time the employee is present and working. In other words, the cost is expensed when the benefit is being earned by the employee, not when the benefit is being used by the employee. (However, the Financial Accounting Standards Board generally allows for sick days and holidays not to be accrued.)
To illustrate, assume that an employee works full-time for the entire year 2022 and as a result earns one week of vacation to be taken anytime during the year 2023. In the weeks/months of the year 2022 (when the employee is working), the employer debits Vacation Expense and credits Vacation Liability. In 2023, when the employee takes the vacation earned in the previous year, the employer records the gross amount of the vacation check with a debit to Vacation Liability (instead of Vacation Expense or Wages Expense).
8. Employer contributions toward 401(k), savings plans, and profit-sharing plans
If an employer is required to contribute company money into an employee's savings program or profit-sharing plan, the contribution should appear as an expense in the period when the employee earned the company contribution. It is also likely that the company will have the expense and the liability before the company actually pays the amount. This situation requires the company to record an adjusting entry in order to match the expense to the proper accounting period.
9. Employer contributions to pension plans
Some companies provide pensions for their employees. This means their employees will receive ongoing monthly payments after they retire from the company. The matching principle requires that the cost of the benefit should be recognized during the years that the employees are working (earning the benefit), and not when the employee is retired.
Note: In effect, pensions (and other benefits) are part of the compensation package given to employees working at a company. While some parts of the compensation package are paid out during the time the employee is working, other benefits are deferred until the employee is retired. The cost of the entire compensation package, however, must be expensed or assigned to products manufactured when the employee is working, so that the cost of the employee's work is matched with the revenue resulting from the employee's work.
The concept is that in the years that the employee works, the company will charge Pension Expense and will credit either Pension Payable or Cash. For more specifics on pensions, you are referred to an Intermediate Accounting text or to the Financial Accounting Standards Board's website www.fasb.org.
10. Post-retirement health insurance
Some companies continue to provide health insurance coverage to employees after they have retired. This retiree benefit is considered to be part of the compensation package earned by employees while they are working. Again, accrual accounting and the matching principle require that the cost of this future insurance coverage be expensed (or assigned to manufactured products) during the years the employees are working by debiting an expense and crediting a liability. During the employees' retirement years, the company's payment for insurance will reduce the company's liability and will reduce its cash.
To learn more on the accounting for post-retirement benefits, such as health insurance coverage, you are referred to an Intermediate Accounting text and/or to the Financial Accounting Standards Board's website www.fasb.org.