- Along with employee wages, an employer's payroll liabilities include payroll taxes, voluntary employee deductions and payroll service costs.
- Payroll taxes are paid by both the employer and the employee.
- Payroll software can automate payroll processes, streamline payroll reporting and help prevent payroll fraud.
- This article is for employers who want to know more about payroll liabilities and how to pay and track them.
Liabilities are a fact of life for a business owner. Payroll liabilities affect not only the health of your business but also the livelihoods of your employees. These liabilities must be paid in a timely manner and tracked closely. Otherwise, businesses could risk high employee turnover, as well as fines from the U.S. Internal Revenue Service (IRS).
You have options when it comes to managing your payroll liabilities. Whether you choose to conduct payroll yourself, hire an accountant or invest in payroll software, this guide will help you learn the basics of payroll liabilities, including the different types and how to track them.
What are payroll liabilities?
Payroll liabilities are payroll expenses a business owes but has not paid. These liabilities can appear every time you run payroll. Obligations may include employee compensation, withholdings, and expenses such as the employer's share of Social Security and Medicare taxes.
Types of payroll liabilities
The most apparent liability when you run payroll is employee wages. Employees can receive pay daily, weekly, twice a month or on any other agreed-upon schedule. Before payroll is processed, the unpaid wages are liabilities, since you owe money to your employees for work they've already completed.
Wages are calculated differently depending on whether workers are salaried or hourly.
- Salaried workers: Divide their annual salary by the number of pay periods in a year to find the amount for a single pay period. Additional amounts may include bonuses or incentives.
- Hourly workers: Multiply the total hours they worked by the agreed-upon hourly rate. Additional amounts may include overtime pay or incentives.
Did you know? As an employer, you do not have tax liabilities when working with contractors or freelancers. Contract workers are required to pay their own taxes on a quarterly or annual basis.
Paid time off (PTO)
Keeping a PTO liability account offers more benefits than just knowing when your employees have taken a day off. The main reason to keep track of employee PTO is knowing exactly how much money you will have on hand if an employee quits without using their PTO.
Keeping track of PTO is straightforward when you're using the best payroll software. First, input the formula you use to give employees PTO. For example, they might earn 0.05 PTO hours for every hour worked. Once the PTO rate and hours worked are logged, this number is multiplied by the employee's hourly rate. The sum is the money you would be liable for if the employee quit without using their PTO.
If your business does not allow PTO to roll over from one year to the next, the PTO accruals are negated at the end of the year. Likewise, if your business has an unlimited PTO policy, PTO accrual doesn't apply.
Every employer must withhold payroll taxes from employees and submit these withholdings to the IRS along with their own tax payments. But you don't automatically transfer the taxes to the IRS when you withhold these funds. Payroll taxes are considered liabilities until your deadline to transfer funds to federal, state, and local agencies.
Payroll tax withholdings include the following:
- Federal income tax. This is all withholdings that encompass the employee's annual income and filing status (married, single, etc.).
- State income tax. Depending on the state, there are different rules for withholding and paying state income tax. Some states don't charge income tax.
- Social Security and Medicare tax (FICA). Social Security and Medicare taxes are withheld from gross pay at a FICA tax rate of 7.65% (for both employers and employees). All self-employed workers pay both amounts, for a total of 15.3%, but can deduct one-half of self-employment taxes when completing their tax returns.
- Federal Unemployment Tax Act (FUTA) and State Unemployment Tax Act (SUTA). Only employers are required to pay FUTA taxes. Employers pay unemployment taxes, and along with money from the federal government and states, employees can collect weekly payments when they lose their job.
- Workers' compensation insurance. If a state requires it, an employer must purchase workers' compensation insurance. This insurance helps protect a company from lost revenue if a worker gets hurt on the job. Workers' compensation insurance pays for medical expenses and lost wages of the affected employee. The insurance is 100% paid by the employer, and the cost can vary by the industry and the number of workers employed.
- Wage garnishments. If an employer receives a notice that their employee has a court-ordered wage garnishment, an employer must withhold the correct amount of employee pay and forward the money to a third party. The court generally provides this information. Wage garnishments are taken out based on the employee's income before any deductions are made except for federal, state, and local taxes; other wage garnishments; mandatory retirement contributions; and court-ordered child support.
To accurately calculate employee payroll taxes, you must have your employees fill out and submit Form W-4.
Other types of employees your business might work with include contractors and freelancers, who typically charge an hourly rate or a flat fee. These workers usually fill out a 1099 form instead of a W-4.
Did you know? As of 2021, seven states don't collect income taxes: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming.
Payroll service costs
If you use an accountant, payroll software or professional employer organization (PEO) to manage payroll, these costs will also be added to your payroll liabilities.
Payroll companies generally charge employers in three ways: per frequency, per employee per month (PEPM), and fixed pricing. PEPM pricing is the most popular and can be the most cost-effective. For example, if you pay per frequency and process payroll weekly, you will pay the payroll fee weekly.
If you choose a fixed pricing plan, you may be paying for more workers than you have. For example, if the fixed plan charges $150 for up to 25 employees and you only have nine employees, a PEPM plan could be significantly cheaper. Plus, fixed plans often have an employee cap, which is not ideal for companies that are planning for exponential growth.
Other payroll costs
Along with federal, state and local tax responsibilities, as an employer, you are also responsible for voluntary deductions. These may include the following:
- Health, dental, vision and life insurance premiums. Any contribution from the employer for employee health plans is a payroll expense. The remainder of the premium paid by the employee is deducted from pretax pay (before any taxes are deducted). If an employee's total annual medical expenses exceed 10% of their adjusted gross income, they can itemize their medical expenses using Form 1040, Schedule A: Itemized Deductions.
- Retirement contributions. Employees contribute to their own retirement plans. Employers only mark retirement plans as an expense if they offer a company match.
- Union dues. The employer's responsibility is to deduct union dues from the worker's pay and forward them to the appropriate union. Union dues are calculated post-tax, which means there are no tax benefits. However, employees can use the cost of union dues when itemizing their annual taxes as an after-tax deduction.
All of these withholdings are liabilities until you transfer the money to the appropriate agencies.
Payroll liabilities and how to pay them
|Liability type||Payment method|
|Gross wages||Pay to employees via paper check or direct deposit.|
|Federal income taxes||Use Form 941 to report and file.|
|FUTA taxes||Use Form 940 to report and file.|
|Medicare and Social Security taxes (FICA)||Use Form 941 to report and file.|
Tip: Tax law changes, employee status changes, and workers who change tax and withholding information can significantly change payroll liabilities each pay period.
How to track payroll liabilities
It's essential to keep your payroll organized and up to date. Doing so will ensure your business runs smoothly and can handle financial growing pains as they arise.
- Keep copies of payroll documents and make sure to date them. Keeping copies will help you keep track of due dates.
- Set reminders to meet your payroll liability deadlines.
- Have a cash reserve to pay your employees on time even if your sales are in the red.
- Open a separate payroll account if paying your employees out of your business account gets too complicated.
- Use payroll software that offers automated wage and tax calculations. Some payroll software services will deposit your payroll tax liabilities for you. You can read about some of the top payroll software solutions in our review of OnPay and our Rippling review.
Most payroll software solutions are affordable, considering they automate processes and eliminate human error. Payroll software can also help automate employee onboarding, company training, tax filing, payroll and deduction errors, and more.