Why Proper Payroll Accounting Is Critical

Accurate payroll accounting is important to businesses of all sizes.

Avoiding sloppy payroll accounting ensures accurate tax returns, reduced cost from accountant untangling and no omissions of valuable tax deductions.

Few businesses realize that the Internal Revenue Service makes an accuracy assessment by comparing payroll figure consistency on a variety of filed reports. No business escapes notice by the IRS.

The person with authority over business payroll matters is personally liable for accounting of wages and payroll deductions. This means that the boss who signs payroll tax returns is required to certify that payroll taxes are correctly calculated and remitted. Total gross wages are reported on payroll forms that are normally submitted quarterly.
Amounts on the payroll forms must match wages and payroll tax expense on the income tax return.

Businesses with workers must separately account for taxes withheld from wages and the payroll taxes paid as employer expenses.

The withheld amounts are not an expense for payroll taxes. These are merely part of the compensation paid to employees. You therefore have to account for withheld taxes as “wages” expense.

Your accounting system must record gross compensation paid to employees before any deductions. Most fringe benefits you provide employees are also recorded as gross wages expense. Tax laws permit excluding some benefits – notably health insurance paid according to certain rules. Accurate payroll accounting requires tracking types of withheld amounts and subsequent remittances.

Some deductions from wages reduce an employee’s compensation subject to income tax but do not reduce wages subject to Social Security and Medicare taxes. A prominent example is retirement plan contributions made by an employee. These are part of the business expense for “wages.” The only “retirement plan” expense of a business is contributions to retirement accounts by the company that are not withheld from wages.

Every year, accounting firms spend an extraordinary amount of time preparing income tax returns that show expenses for “wages” that match payroll tax reports. This process transpires because businesses fail to correctly account for tax withholding from employee pay in the “wages” expense category.

When amounts are withheld from wages, they are described as accrued by the business until they are later paid.

This same accrual for future remittance also occurs with the payroll tax expenses of the business.

Each employer pays contributions to Social Security and Medicare based upon wages. These are the tax amounts not withheld from worker compensation. They are payroll tax expenses of the business.
Unemployment tax is another employer expense not withheld from wages.
Even a business that uses cash-basis accounting is entitled to deduct un-remitted payroll taxes that accrued for prior pay dates. The payroll tax expense of the business is recorded when employees are paid.

Both withholdings from gross wages and the employer payroll taxes are simply payable in the future. But the wages and employer tax liability are accounted for as expenses on payday.

What You Need to Know About Taxes and Employee Tips

Tip income is an important area of concern for several types of businesses. Employers are responsible for including tips received by workers on their W-2 forms.

Workers must report to their employers the total tips received in a calendar month whenever the amount exceeds $20. Employers include reported tips in calculations for withholding of income tax as well as Social Security and Medicare taxes.

Box 1 on a W-2 for wages should include reported tips. In addition, Boxes 3 and 5 for Social Security wages and Medicare wages are applicable for reported tips.

Paychecks can possibly have insufficient wages to cover withholding requirements on tip income. Any required withholding that isn’t collected is reported in a special box on Form W-2. This figure should match the adjustment on an employer’s quarterly federal payroll reporting. Alternatively, workers may give their employers money from collected tips to cover calculated withholding amounts.

Food and beverage businesses have a special rule about tips. When reported tips are less than 8% of gross receipts, most food and beverage establishments must calculate the deficiency. This figure is then allocated among employees according to a formula based upon proportions of gross income or hours worked. Allocated tips are indicated in a special box on Form W-2. No withholding is required on allocated tips.

The IRS has escalated enforcement of tip-reporting rules. Businesses in industries where tipping of employees is common should ensure that compliance measures are executed for all income from tips.