A payroll is a company’s list of its employees, but the term is commonly used to refer to:
- the total amount of money that a company pays to its employees
- a company’s records of its employees’ salaries and wages, bonuses, and withheld taxes
- the company’s department that calculates and pays these.
Payroll in the sense of “money paid to employees” plays a major role in a company for several reasons.
From an accounting perspective, payroll (also referred to as “wages”) is crucial because payroll and payroll taxes considerably affect the net income of most companies and because they are subject to laws and regulations (e.g. in the US, payroll is subject to federal, state, and local regulations).
From a human resources viewpoint, the payroll department is critical because employees are sensitive to wage errors and irregularities: Good employee morale requires wages to be paid timely and accurately. The primary mission of the payroll department is to ensure that all employees are paid accurately and timely with the correct withholdings and deductions, and that the withholdings and deductions are remitted in a timely manner. This includes salary payments, tax withholdings, and deductions from paychecks.
Before considering the wage taxes, it is necessary to talk about the basic formula for the Net Pay. From gross pay (the salary paid to the employee) one or more deductions are subtracted, to arrive at Net Pay. Thus the employee’s gross pay (pay rate times number of hours worked, including any overtime) minus wage tax deductions, minus voluntary wage deductions, is equal to Net Pay. Payroll tax deductions play a critical role and because they are provided by law they are known as Statutory payroll tax deductions.
The employer must withhold wage taxes from an employee’s check and hand them over to several tax agencies by law. Wage taxes include the following:
- Federal income tax withholding, based on withholding tables in “Publication 15, Employer’s Tax Guide”by Internal Revenue Service – IRS;
- Social Security tax withholding.The employee pays 6.2 percent of the salary or wage, up to $118,500 (as of 2015–2016).
- ). The employer also pays 6.2 percent in Social Security taxes. If you are self-employed, you pay the combined employee and employer amount of 12.4 percent in Social Security taxes on your net earnings;
- Medicare tax.The employee pays 1.45 percent in Medicare taxes on the entire salary or wage. 0.9% is added for the salary portion bigger than $200,000 (only for the employee portion). The employer also pays 1.45 percent in Medicare taxes (regardless if the amount is bigger than $200,000). If you are self-employed, you pay the combined employee and employer amount of 2.9 percent (3.8% for the portion bigger than $200,000) in Medicare taxes on your net earnings;
- State income tax withholding;
- various local tax withholding, such as city taxes, county taxes, school taxes, state disability, and unemployment insurance.
References include the following publications:
- Publication 15, (Circular E), Employer’s Tax Guide. This publication explains employer’s tax responsibilities. It explains the requirements for withholding, depositing, reporting, paying, and correcting employment taxes. It explains the forms any employer must give to its employees, those employees must give to the employer, and those employers must send to the IRS and SSA (Social Security Administration). This guide also has tax tables needed to figure the taxes to withhold from each employee;
- Publication 15 – A, Employer’s Supplemental Tax Guide. This publication supplements Publication 15 (Circular E), Employer’s Tax Guide. It contains specialized and detailed employment tax information supplementing the basic information provided in Publication 15 (Circular E);
- Publication 15-B. Employer’s Tax Guide to Fringe Benefits. This publication supplements Publication 15 (Circular E), Employer’s Tax Guide, and Publication 15 – A, Employer’s Supplemental Tax Guide. This publication contains information about the employment tax treatment of various types of noncash compensation.
In the earlier part we have considered payroll taxes related to employee’s side. Now it’s the moment to talk about the Employer Payroll Taxes Employers are responsible for paying their portion of payroll taxes. These wage taxes are an expense over and above the expense of an employee’s gross pay. The employer-portion of wage taxes include the following:
- Social Security taxes (6.2% up to the annual maximum);
- Medicare taxes (1.45% of wages);
- Federal unemployment taxes (FUTA);
- State unemployment taxes (SUTA).
Very often you can hear people using FICA in their terminology. FICA stands for the Federal Insurance Contributions Act and the FICA tax consists of both Social Security and Medicare taxes. As we explained earlier both parties pay half of these taxes. Employees pay half, and employers pay the other half. Social Security and Medicare taxes are paid both by the employees and the employers. In summary together both halves of the FICA taxes add up to 15.3 percent.
Any employer is responsible for paying the employer’s share of wage taxes, for depositing tax withheld from the employees’ paychecks, preparing various reconciliation reports, accounting for the wage expense through their financial reporting, and filing wage tax returns. As you see this suite of employer payroll tax responsibilities is far above issuing paychecks to employees.