Payroll liabilities can affect the health of your business and the people who work for you. Payroll is a large part of operations and almost 70% of small businesses say payroll taxes are a moderate or significant burden. Payroll tasks will overlap with confusing tax rules and complex employment laws, and thus, liabilities in this area should be thoroughly understood.
Here’s a quick guide on the different types of payroll liabilities, how to pay them, and best practices to ensure you never run into any accounting problems.
What are Payroll Liabilities?
Every time you run payroll, there will be expenses a business owes but has not paid. These are called payroll liabilities and can include employee compensation (earned but not yet received), taxes withheld, expenses (like Social Security and Medicare taxes), and other payroll-related costs. Most items do not remain a payroll liability for very long.
Every employer must know which payroll liabilities they are responsible for. Since these liabilities represent funds you must pay out at a future date, they are easy to overlook and forget about. However, if a business doesn’t take these expenses into account when creating a budget, you could run out of funds down the road.
What are the Types of Payroll Liabilities?
When it comes to payroll liabilities, there are a few different types to keep an eye on. These include:
The first, and most obvious payroll liability is employee wages. Staff can receive funds daily, weekly, monthly, or at any set time you agree upon. Prior to processing payroll, these unpaid wages are considered liabilities. That’s because you owe money to employees for work they have already completed.
Employee wages are typically calculated differently depending on whether the worker is hourly or salaried. Salaried employees divide their annual salary by the number of pay periods in a year. Hourly employees multiply the total hours worked by the agreed-upon rate. Additional amounts may include overtime, bonuses, or other incentives.
An employer does not have tax liabilities with contractors or freelancers. You are only responsible for contingent workforce payments. Contract workers pay their own taxes; on a quarterly or annual basis.
Paid Time Off (PTO)
Paid time off (PTO) is another form of payroll liability and keeping track of it is important. For starters, it enables a business to know exactly how much money they will have on hand if an employee quits without using their PTO. As a business owner, it helps to keep a payroll liability account to cover any unexpected expenses.
Tracking PTO is a lot easier with payroll software (like Quickbooks). First, input the formula used to give employees PTO. This may be, for example, .05 PTO hours for every hour worked. Once the PTO rate and hours are logged, this is multiplied by the hourly rate. The sum is what you would be liable for if an employee quits without using paid time off.
If your business does not allow PTO to roll over, then PTO accruals are negated at the end of the year. The same goes for if your business has an unlimited PTO policy. Then PTO accrual doesn’t apply. This is why accrual accounting is so important when managing payroll liabilities. It helps to point these things out.
Every employer in the United States must withhold payroll taxes from employees and submit these withholdings to the IRS, along with their own tax payments. The payroll tax expenses are considered liabilities until the deadlines to transfer funds to federal, state, and local agencies are met.
The withholdings for payroll tax include the following:
Federal Income Tax
All the withholdings from employee paychecks that encompass annual income and filing status (married, single, etc.).
State Income Tax
There are different rules for withholding and paying state income tax depending on the state. Some states don’t require income tax withholding at all. Local income tax all depends on state law.
Social Security and Medicare Tax
The Federal Insurance Contribution Act (FICA) requires the payment of Social Security and Medicare taxes. These are withheld from gross pay at a FICA tax rate of 7.65% (for both employers and employees).
All contract workers pay both amounts, for a total of 15.3%, but can deduct exactly half of self-employment taxes when completing their tax returns.
Federal Unemployment Tax Act (FUTA) and State Unemployment Tax Act (SUTA)
Employers are required to pay FUTA taxes. With this money, along with funds collected from the federal government and states, employees can collect weekly payments when they lose their job.
Workers’ Compensation Insurance
An employer must purchase workers’ compensation insurance if the state requires it. This insurance protects your company from lost revenue if a worker gets hurt on the job.
Workers’ compensation insurance will pay for lost wages and medical expenses of the affected employee. The insurance is 100% the employer‘s expense. The cost can also vary by the industry and the number of workers.
If a business receives a notice that their employee has a court-ordered wage garnishment, you must withhold the correct amount of employee pay and forward it to the third party accordingly. The court will usually provide this information.
Wage garnishments are taken out before any deductions are made (except for federal, state, and local taxes).
The Right Documents
To accurately calculate employee payroll taxes, you must have your employees fill out and submit Form W-4. According to a recent report, only 25% of workers have updated their W-4, so it’s important to be aware of these things.
Other types of employees may include contractors and freelancers, who typically charge an hourly rate. These workers will fill out a 1099 form instead of a W-4. This is often the case with international payroll as well.
International payroll is paying net compensation to a global workforce (both employees and independent contractors) in multiple countries. It requires compliance with country-specific regulatory requirements. The global employee payroll process includes withholding, contributing, and submitting income and payroll taxes to local government agencies.
Payroll Service Costs
Whether you use a bookkeeper, accounting software, or a professional employer organization (PEO) to manage payroll, there are certain costs that will always be included in your payroll liabilities.
Payroll companies typically charge employers in three different ways:
- Per frequency
- Per employee per month (PEPM)
- Fixed pricing
PEPM is the most common pricing scheme and the most cost-effective as well. That’s because if you pay by frequency, you pay every time you process payroll, and fixed pricing may ask for you to pay for more workers than what you have.
Additional Payroll Costs
On top of federal, state, and local tax, an employer is also responsible for an employee’s voluntary deductions. These can include health insurance and life insurance premiums. Any contribution to health plans is a payroll liability. The remainder of the premium (paid by the employee) is deducted from pretax pay.
Retirement contributions are another payroll cost. Employers only mark retirement plans as an expense if they offer a company match.
Union dues should also be considered. It is the employer’s responsibility to deduct union dues from pay and forward them to the appropriate party. These expenses are calculated post-tax—which means there are no tax benefits.
All of the withholdings mentioned above are liabilities until the money is transferred to the appropriate agencies.
Payroll Liabilities and How to Pay Them
In order to ensure all payroll liabilities are met, follow these steps:
- Collect employee data (using W-4)
- Calculate gross wages using worker contracts
- Compute the amounts to withhold
- Pay each worker’s net pay (after withholding amounts)
- Record payroll liabilities for the amounts that represent a business expense (ex. FICA taxes)
- Submit amounts to each third party using the proper forms
- Reclassify payroll liability balances into payroll expense accounts
Here are how the most common payroll liabilities are paid:
- Gross wages: Paid to workers by direct deposit or check
- Federal income taxes: Form 941 to report and submit federal tax withholdings
- FICA (Medicare and Social Security taxes): Form 941 to report and submit tax payments
- FUTA taxes: Use Form 940 to report and file
Additionally, there are variables that may affect your payroll calculations from one pay period to the next. This, in turn, will change your payroll liabilities. Changes in the tax law and new employees are two factors that can affect expenses. Workers that change their tax withholdings will also cause a business to recalculate.
When it comes to handling federal payroll tax liabilities, make sure to deposit them according to the IRS schedule. You can either deposit payroll tax liability monthly or semiweekly, depending on your previous tax liability.
How to Track Payroll Liabilities
Like any other accounting duty, tracking payroll liabilities is critical to a healthy balance sheet. According to a recent report, 25% of small businesses still use pen and paper to track finances, while 45% don’t have their own accountant or bookkeeper. To avoid missing deadlines or paying fines, you must keep track of every payroll liability on your reports. Here are a few ways to ensure you have all your ducks in a row:
Always use a reliable system to run payroll. The right accounting software means a business doesn’t have to worry about wage or tax calculations. Most solutions are affordable, automate processes, and eliminate human error. It can also help with employee onboarding, company training, tax filing, and deduction of errors.
If you opt for a full-service payroll company, you also don’t have to stress about depositing payroll tax liability.
Keep copies of all documents related to payroll to remain organized and up-to-date. Make sure they include relevant dates so you understand when the liabilities were incurred, and when they are due. You can also set automatic reminders to make sure deadlines are met.
Use Payroll Accounting
Another way to keep track of liabilities is to use payroll accounting. This will give a business a clear record of liabilities, including taxes and wages. It will also demonstrate whether you’ve paid payroll expenses or not. A company should consider opening a separate payroll account to avoid mixing payroll cash with regular funds.
Payroll Liabilities Best Practices
If you want a smooth and steady payroll experience, there are a few things to keep in mind. To ensure employees, the IRS, and state agencies get the money owed to them, consider a few of these best practices:
- Use a reliable payroll system
- Always have a cash reserve to cover payroll if money is tight
- Open a separate payroll bank account
- Know your deposit schedule
- Set reminders
- Keep accurate records
Importance of Payroll Liabilities
In 2020, the IRS assessed about $6 billion in employer penalties. Payroll liabilities not only affect the health of your business, but the livelihood of your employees as well. If these expenses are not paid in a timely manner and tracked closely, the IRS can levy fines against you. You may also see a higher rate of employee turnover if there are continuous issues with payroll.
Understanding what constitutes a payroll liability, how to address it, and the best ways to track the expense will ensure a business is aligned with federal regulations. It also shows employees that you care about how they get paid.