When a business pays employees wages the federal government requires that the employer withhold a portion of the employees gross wages to cover income and Social Security taxes. Social Security taxes actually consist of two separate taxes FICA and Medicare. The Medicare tax rate is 1.45% of all gross wages while the FICA rate is 6.2% of gross wages up to a ceiling which changes every year (In 2006 the ceiling was $94,200). Additionally the employer must pay a dollar for dollar match for every dollar of Medicare and FICA taxes withheld. This means that the government collects 2.9% of total gross wages in Medicare taxes and 12.4% of gross wages up to the annually set ceiling.
Furthermore an employer is expected to withhold from an employee’s gross wages an amount to cover the expected amount of federal income taxes the employee will owe for the year. Generally the amount withheld will depend upon the amount and frequency of gross wage payments as well as the employee’s filing status and number of personal exemptions claimed on his or her income tax return.
In addition to these federal income and social security taxes, state and local jurisdictions usually levy some form of income tax and require that employers withhold an amount from each gross pay check to defray these expected liabilities. The amount of required withholdings for these taxes also varies with the frequency and amount of gross pay.
Finally, the federal government and almost all state jurisdictions require that the employer pay into a reserve fund for unemployment insurance. This amount is generally not withheld from employees gross wages but rather is levied on the employer based on certain rates determined by the state jurisdiction and the balance in the employer’s reserve account.
There is a distinction between taxes that are withheld from employees’ wages and taxes that the employer has to pay above the amount of gross wages. The employers’ match of Social Security taxes and the unemployment taxes payable to the unemployment reserve account are called employment taxes and they constitute an expense above and beyond gross payroll payments. In accrual accounting the liabilities for both withholding and payroll taxes should be recorded when payroll checks are issued.
Example. Joint Ventures hires a pilot, L. Reed to fly some of deliveries. After making two flights he is owed a gross wage of $1,000. Assume the following payroll tax withholdings and payroll tax liabilities associated with this gross payroll:
This is the entry when the payroll check is issued:
Notice that there is no expense associated with payroll taxes withheld. The full expense is reflected in gross wages. Notice also that there are two entries needed at the time the payroll check is issued. One to reflect the gross payroll and withholdings and another to record the employer payroll tax liability.
The payment of withheld taxes represents a very special type of liability for employers. If an employee’s gross wages have been subject to tax withholdings then the government credits the employee with taxes paid whether or not the employer actually turns the withheld taxes over to the government. Because the government must credit the taxes withheld to the employee, when an employer fails to turn over withheld taxes the government in effect is making an unauthorized loan to the employer. The government does not like making unauthorized loans.
For the above reason the penalties for failure to pay over withheld or other payroll taxes are subject to very steep penalties. Furthermore unpaid withheld payroll taxes cannot be discharged in bankruptcy unlike other debts and regular income tax liabilities.
The required timing for paying withheld taxes and other payroll taxes is based upon how much is owed. The greater the amount owed the shorter the period the employer has to make the required payments. This is the entry for payment of the payroll withholding and taxes: