Payroll taxes are taxes levied on employees and/or employers which must be deducted by the employer at the time of processing of payroll. In US, major payroll taxes include income taxes, FICA taxes (social security tax and Medicare tax), FUTA tax and SUTA, etc.
At the time of payment of salaries, employers deduct taxes borne by the employers, match them if required and deposit it in government treasury. The payroll expense equals the accrued gross salaries plus employer payroll taxes and the amount paid to employees is net of any employee payroll taxes.
In US and many other countries, employers are required to withhold the income tax from its employees by working out income tax applicable to them based on the information they provide. The income tax withheld may differ from the ultimate income tax liability of the employee which is ascertained when he files his return.
Since income tax is a withholding, it has no expense implication for an employer. The employer just acts a conduit for transfer of income tax to the government. Periodic deduction from salary is more manageable for both the employees and the government because otherwise employees might be required to come up with a huger sum at the time of filing of return.
FICA stands for Federal Insurance Contributions Act, the law the promulgates the taxes which are applicable to both employees and employers. It has two components: social security tax and Medicare tax.
Social security tax
Social security tax is a FICA tax charged to both employees and employers to fund the social security institution in the US. It is also referred to as Old Age, Survivors, and Disability Insurance.
The current social security tax rate is 12.4% which is equally shared by the employee and employer. The social security tax has an upper limit called social security wage base. The cap is $128,400 for 2018 and is adjusted periodically in line with cost of living adjustment. Social security tax is not applied to any income earned above the upper limit.
Let’s say you have two employees: Mark earnings $110,000 per annum and Jane earnings $150,000. The social security tax withheld from Mark and Jane would be $6,820 ($110,000×6.2%) and $7,960.8 ($128,400×6.2%) per annum respectively. The employer will be required to make a matching contribution i.e. at 6.2%.
Please note that Jane’s annual income is $150,000 which is higher than the social security wage base. Hence, social security tax is applied only to the $128,400.
Medicare tax is a flat tax applicable at the rate of 2.9% to all compensation income and shared equally by employees and employers. It means that 1.45% of the tax is deducted from employees and the other half is borne by the employers. It is also called federal hospital insurance tax.
There is no upper limit on Medicare tax unlike the social security tax. Individuals earnings more than $200,000 are liable to an Additional Medical Tax at the rate of 0.9% on income in excess of $200,000. The additional medicare tax does not apply to employers.
In our example above, total annual Medicare tax would be $7,540 (=($110,000 + $150,000) × 2.9%) which would be equally shared by the employees and employers i.e. $3,770 would be deducted from salaries of Mark and Jane proportionately and an equal amount would be paid by the employer. Since no employee earns more than $200,000, no additional medicare tax is applicable.
Unemployment insurance taxes
Unemployment insurances taxes are levied by state and/or federal government on employers only as percentage with an upper limit. The federal unemployment insurance tax is also called FUTA tax where FUTA stands Federal Unemployment Tax Act, the law under which the taxes are promulgated. The state unemployment taxes are called SUTA taxes.
The state unemployment taxes are different in different state in terms of the tax rate and the base wage to which the tax applies.
The federal unemployment tax is applicable at the rate of 6% only to the first $7,000 of each employee’s annual wages. A maximum credit of 5.4% is applicable in relation to the state unemployment taxes paid.
Continuing the example above, let’s say the SUTA tax rate is 5.4%, the state unemployment tax obligation equals $756 (=2 × $7,000 × 5.4%). The FUTA tax offers a credit of maximum 5.4% in respect of state unemployment taxes paid. FUTA in this example would be $112 (=2 × $7,000 × (6.2% - 5.4%)).
The payroll taxes deducted from employees do not increase the total payroll expense because they decrease the net cash payment to employees. The employer just acts a channel for collection of employee payroll taxes. The employer taxes such as the matching amount of social security and medicare taxes and the unemployment insurance taxes are additional expense which results in increase in payroll expense.
Let’s assume income tax of $1,500 and $2,000 is required to be deducted from Mark and Jane each month on account of federal income tax. Using the figures from the examples above, the employer need to make the following journal entry to record the monthly payroll expense for Mark and Jane:
|Payroll taxes expense||1,618|
|Income taxes payable||3,500|
|FICA taxes payable||3,092|
|SUTA tax payable||63|
|FUTA tax payable||9|
The following table summarizes the necessary calculations:
|Salaries expense||GS||21,667||Total annual compensation of $260,000 (=$110,000 + $150,000) divided by 12.|
|Income taxes payable||IT||3,500||Based on information provided by each employee.|
|Social security taxes - deducted||SSTD||1,232||6.2% of the ($110,000/12) and 6.2% of the monthly social security base wage ($128,400/12)|
|Social security taxes - employer||SSTE||1,232||The employer is required to match the employee contribution for social security tax.|
|Total social security taxes||SST = SSTD + SSTE||2,463||Sum of social security tax deducted and social security tax borne by employer.|
|Medicare tax - deducted||MCD||314||1.45% of the monthly wages|
|Medicare tax - employer||MCE||314||The employer is required to match the employee charge of medicare tax.|
|Total medicare taxes||MC = MCD + MCE||628||Sum of medicare taxes deducted from employee and paid by employer|
|FICA tax payable||FICA = SST + MC||3,095||Sum of social security tax and medicare tax|
|SUTA taxes payable||SUTA||63.00||5.4% of the first $7,000 annual wage (2 × $7,000/12 × 5.4%)|
|FUTA taxes payable||FUTA||9||(6.2% - 5.4%) × $7,000/12 × 2|
|Payroll tax expense||PT = SSTE + MCE + SUTA + FUTA||1,620||Sum of employer portion of social security tax and medicare tax and full amount of SUTA and FUTA|
|Net payment to employees||N = GS - IT - SSTD - MCD||16,619||It equals gross salary minus income tax deduction minus deduction of employee portion of social security tax and medicare tax|