Payroll can feel like a mystery. You input some information into payroll software and out comes a pay stub. If everything is set up correctly, employees receive direct deposits, the IRS receives its payments, benefits and child support are paid, and the process runs like a well-oiled machine.
Until it doesn’t.
Having a basic understanding of how payroll works, including payroll taxes and forms, can help you identify and address issues when they arise. It’s also key to properly recording payroll in your financials.
Payroll Basics
Payroll is built on a few simple formulas:
- Employee Direct Deposit = Wages – Employee-paid taxes – Employee-paid deductions
- Total Cost of Payroll to the Company = Wages + Employer-paid taxes + Employer-paid benefits
Understanding Payroll Taxes
There are several types of payroll taxes:
- Federal Withholding – This tax is entirely based on the individual employee’s elections (e.g., single, married, number of allowances) and is fully paid by the employee. It’s withheld from their wages.
- Social Security – A flat 6.2% of gross wages is paid by the employee and another 6.2% by the employer. The employee’s share is withheld from wages; the employer’s share is an additional company expense.
- Medicare – A flat 1.45% of gross wages is paid by both the employee and employer, similar to Social Security.
Federal Withholding, Social Security, and Medicare totals are reported quarterly to the IRS on Form 941. Payments are sent to the IRS after each payroll run and include both the employee and employer portions. If the total amount paid during the quarter does not match what’s reported on Form 941, expect a letter from the IRS—possibly with penalties and interest.
- FUTA (Federal Unemployment Tax) – Paid entirely by the employer and reported annually on Form 940. The IRS typically requires estimated quarterly payments, and the total of those payments must match the amount reported on the annual form.
- SUTA (State Unemployment Tax) – In Texas, this is often called TWC or Texas Workman’s Comp. It is paid solely by the employer and calculated on the first $9,000 of each employee’s wages. The rate changes yearly (you’ll usually receive a letter in January or February). If QuickBooks processes your payroll, you’ll need to update the rate manually. If a payroll company handles it, send them the updated rate letter. SUTA is reported and paid quarterly with Form TX C-3 to the State Comptroller.
Capturing Payroll in Your Financials
If you use QuickBooks for payroll, various payroll items can be mapped correctly for financial reporting. Many payroll companies can also integrate directly with QuickBooks Online or provide an importable file.
To capture the total cost of payroll on your Profit & Loss statement, include:
- Gross Wages – The total wages paid, not just the net direct deposit.
- Employer portion of Social Security and Medicare
- FUTA and SUTA
- Employer-paid benefits, such as insurance or IRA matching
Some payroll-related items are collected from employees and remitted on their behalf. These are liabilities, not expenses, and should appear on the Balance Sheet. These liability accounts should return to $0 regularly as payments are made:
- Federal Withholding, employee portion of Social Security and Medicare
- Employee IRA contributions and insurance premiums
- Court-ordered child support withheld from employee paychecks
Keep It Clean and Consistent
Once payroll is set up properly in your financials, maintaining it is fairly straightforward. Accurate payroll records help identify missed payments and ensure you get full credit for the total cost of your employees come tax time.
If you're unsure how to get set up, contact your payroll provider or accountant. ADKF’s Accounting Services team is happy to help you set up payroll and integrate it properly into your financials. If you’re receiving IRS notices, our Tax Controversy department is also available to assist with payroll tax, sales tax, and federal income tax issues.