When running a business, payroll taxes are a critical component that needs to be managed properly. Not only do you need to pay your employees accurately, but you also have to ensure that the associated taxes are recorded correctly in your accounting system. This article will guide you through how payroll taxes are broken down into your chart of accounts so they appear correctly on your income statement or balance sheet. Handling these types of transactions is a normal part of bookkeeping services.
What is a Chart of Accounts?
Before diving into payroll taxes, let’s quickly recap what a chart of accounts (COA) is. Your COA is a list of all the financial accounts in your company’s general ledger. It’s the backbone of your accounting system, organizing your finances into different categories such as assets, liabilities, income, and expenses.
Payroll Taxes: An Overview
Payroll taxes include various taxes that both employers and employees must pay. These taxes typically include:
- Federal Income Tax Withholding
- Social Security and Medicare Taxes (FICA)
- Federal Unemployment Tax (FUTA)
- State Income Tax Withholding
- State Unemployment Tax (SUTA)
Breaking Down Payroll Taxes in the Chart of Accounts
To ensure payroll taxes show up correctly on your income statement or balance sheet, they need to be recorded in the right accounts. Here’s how you can set this up in your COA:
- Wages and Salaries Expense
- This account records the gross wages and salaries paid to employees before any deductions.
- On the income statement, this will show up as an expense, reducing your net income.
- Payroll Tax Expense
- Separate this into different sub-accounts for clarity, such as:
- Employer FICA Taxes
- Employer FUTA Taxes
- Employer SUTA Taxes
- These accounts reflect the employer’s portion of payroll taxes and are also expenses on the income statement.
- Employee Payroll Tax Withholdings
- This is a liability account that holds the amounts withheld from employees’ paychecks for taxes like federal and state income tax, and the employee portion of FICA.
- These withholdings are recorded as liabilities on the balance sheet because they are owed to the government.
- Payroll Tax Payable
- Similar to employee withholdings, this liability account is used for the employer’s share of payroll taxes until they are paid to the government.
- This shows up on the balance sheet under current liabilities.
Recording Payroll Taxes in the Accounting System
Here’s a step-by-step process for recording payroll and payroll taxes:
- Gross Payroll Entry
- Debit: Wages and Salaries Expense
- Credit: Cash/Bank Account (for the net pay)
- Credit: Employee Payroll Tax Withholdings (liability)
- Credit: Payroll Tax Payable (liability)
- Employer Payroll Taxes Entry
- Debit: Payroll Tax Expense (for each type of employer tax)
- Credit: Payroll Tax Payable (liability)
- Paying Payroll Taxes
- When you pay the taxes to the government, you’ll reduce the liability accounts.
- Debit: Payroll Tax Payable
- Credit: Cash/Bank Account
Example Entry
Let’s say your company’s gross payroll for a pay period is $10,000. The withholdings and employer taxes are as follows:
- Employee federal income tax: $1,500
- Employee FICA (Social Security and Medicare): $765
- Employer FICA: $765
- FUTA: $42
- SUTA: $108
The journal entries would be:
- Recording Gross Payroll:
- Debit: Wages and Salaries Expense $10,000
- Credit: Cash/Bank Account $7,735 (net pay after withholdings)
- Credit: Employee Payroll Tax Withholdings $2,265 (total withholdings)
- Recording Employer Taxes:
- Debit: Payroll Tax Expense $915 (total employer taxes)
- Credit: Payroll Tax Payable $915
- Paying the Taxes:
- Debit: Payroll Tax Payable $3,180 (total taxes due)
- Credit: Cash/Bank Account $3,180
Conclusion
Understanding how to properly record payroll taxes in your chart of accounts ensures that your financial statements accurately reflect your company’s financial health. By categorizing payroll expenses and liabilities correctly, you can maintain clearer financial records, comply with tax regulations, and make more informed business decisions. Handling these types of transactions is a normal part of bookkeeping services. If this process seems daunting, consider hiring a professional bookkeeper to help set up and manage your payroll system effectively.
