Unless you’re a one man show, you probably have employees which means you’re probably paying them and have to deal with payroll accounting. It can be a headache trying to understand all that comes with hiring employees and paying them, dealing with taxes, paying contractors, vacation time – the list goes on. So how do you do it? What exactly does payroll accounting entail? Hold tight because you’re about to get a crash course. Or, you can take a crash course called Learn Accounting. Understand Business.
According to Wikipedia, accounting is the measurement, processing and communication of financial information about economic entities. These “economic entities” can be yourself, your grandma, your business, your school tuition, your mortgage, your investments, and your payroll. Payroll includes anybody that works under you as an employee. This does not include contractors and freelancers. A lot of the time accountants are hired to handle all of the financial details of an operation since they are often well-studied in the area of financial management. However, accountants often come with a hefty price tag so you may be rendered your own personal accountant and for more than just payroll. For those of you feeling a bit like you’re drowning in accounting babble, check out Introduction to Bookkeeping. Payroll accounting may be intimidating, you may be overwhelmed, but let’s tackle this one step at a time.
If you’re new to the being-an-employer gig, make sure you don’t get yourself in trouble and follow whatever the IRS tells you to do. The first step (I’m relaying this from the IRS so yes, pay attention) is to set up a payroll account with the Internal Revenue Service (IRS) when you hire your first employee. The next step is to provide a W-4 form to your newly hired employee which tells you, the employer, how much in taxes should be withheld from their paycheck. The W-4 form is a federal tax withholding document. Most states also have state tax withholding forms that you will need to also give to your new employee. These documents differ from state-to-state so make sure you look up what is appropriate. The more deductions the employee is eligible for, the less you have to withhold.
Salaries and Wages
When you have employees working for you – you have to pay them. Yes, you have too. If they are on your payroll and are putting in hours you are responsible for making sure they are compensated. The Fair Labor Standards Act (FLSA) says so. If you are maintaining salaried employees, you are usually exempt from having to pay them any overtime as salary indicates that they receive annual compensation regardless of the amount of hours worked. However, if you are drilling your salaried employees to the bone with 80-hour work weeks you might want to one: let them know this will happen before you hire them, or two: compensate them through bonuses or some kind of overtime pay. If you are employing people at an hourly rate, this is referred to as their wage. The minimum wage is set by the federal government and can be refined by the state government if they feel it’s appropriate. For example, the federal government has decided that the nationwide minimum wage in the United States is at a whopping $7.25 an hour. However, in Connecticut, the Governor modified the state minimum wage to be a more doable $8.70 an hour.
If you are a company that can afford to offer employee benefits like health, dental, vision or life insurance, these are included in payroll accounting. Included under benefits are holidays, sick days and vacation days. The accountant (or you) is responsible for deducting the employees benefit premium from their paycheck and then subsequently responsible for moving that money into the company benefit plan. You cannot tax these withholdings so deduct them from the employee’s gross wages to figure out their taxable wages. If you’re not offering insurances, forget about this.
Social Security and Medicare taxes combined into FICA, or the Federal Insurance Contribution Act. These tax rates can change year to year and are calculated as a percentage of the employee wages. You are also responsible for withholding federal and state taxes. However, when you withhold these taxes you are doing so based on how much the employee is expected to make that year. It’s rare that the amount you withhold is an exact match for the amount the employee owes.
If you’ve ever been an employee before, you know about the W-2. It can mean money in your pocket (or out of your pocket) come tax season depending on the amount withheld and the amount owed. As an employer you must distribute W-2’s to your employees which reports the total gross and net wages for the year in addition to the tax withholding details. The personal circumstances of your employee (dependents, marital status, salary) determines how much federal and state taxes you withhold. In certain cases when an employee has an exceptionally high amount of exemptions – you won’t have to withhold any of federal or state taxes. And because you are the employer, you don’t have to pay federal or state taxes but are still liable to pay personal FICA taxes.
Other withholdings can include insurance premiums, union dues and pension payments. Current FICA rates are 6.2% for Social Security tax (up to the first $117,000 made by each employee) and Medicare rates are 1.45% for each employee’s wages. Unlike the Social Security Tax which has a cap of $117,000, Medicare taxes are applied to the full wages of each worker.
Gross Pay and Net Pay
Just to clarify, gross pay is the compensation given to an employee including all overtime, bonuses and commission. The net pay is the amount given to the employee after all of the deductions are taken out.
As an employer, you have payroll liabilities. This just means that the money you are withholding from your employee paychecks (and your paychecks) for taxes must be remit to the government within one year of your balance sheet date. You have a liability to pay the government and as long as you owe them money these withholdings are seen as a current liability.
Most employees try to submit their current liabilities to the appropriate government agencies bi-weekly or monthly. If you’re annual liabilities are $1,000 or less, you will probably qualify to submit your payments when you file your tax return on an annual basis.
Direct Deposit vs. Payroll Clearing Account
Direct deposit is the most common and practical way for employers to pay their employees. It’s a seamless and immediate way to transfer money from your payroll account to the employee’s bank accounts. If for some reason an employee’s check is not received, you will have to resubmit the transaction or print a paper check. Payroll clearing accounts are a bit antiquated albeit well-suited for some smaller businesses. All this means is the accountant must have a payroll account at the bank that deals solely with the money being compensated to employees. You’ll have to manually check that there are no payment discrepancies after issuing checks on payday.
Payroll Accounting Software
So, you’re not outsourcing your payroll accounting but, you don’t want to do this all with a pencil and paper either. There is so much software available to employers to help them correctly deal with the complex task of managing payroll. For a review of ten accounting software read Best Accounting Software. Here are a few of the best out there:
- CenterPoint Payroll by RedWing
This software gives you direct deposit options, electronic tax filing, standard and custom earning/deduction codes, easy tracking and a lot of ways to streamline your payroll processes.
- Denali Payroll
Denali helps you process payroll in just a few clicks and can generate reliable records and reports for tax time. It can handle one employee or a thousand and has security features to keep your information confidential.
This is arguably the most popular of all payroll software – but it’s not for everyone. There are more flashy and user friendly programs to use, but if you want to get the job done, you can trust Intuit.
And that’s a wrap. Hopefully you’re head isn’t spinning and you have more answers than questions. IF you’re feeling a little overwhelmed, head over to Finance and Accounting for Startups to get the run down on everything you feel unsure about.