Payroll Taxes

[Andrew Sackville-West]

First, I am not an accountant, but I've kept the books for my (and
many other) businesses for over 15 years and this has always included
either calculating or at least recording payroll. There are some
fundamental mis-understandings of payroll txns below which I'll
attempt to clarify. 

It is important to note that the "expense" method people are using
below will return the same numbers as the "liability" method, but that
the "expense" method is *fundamentally incorrect*. That is, it records
the txns in a way that is not reflective of what actually happens.And
it hampers the ability of the user to get meaningful information back
out of the payroll txns.

On Fri, Jan 11, 2008 at 10:16:20AM +0000, Keith A. Milner wrote:
> On Thursday 10 January 2008 11:43:24 Derrick Hudson wrote:
> > On Sat, Jan 05, 2008 at 09:07:42AM -0500, Matt Burkhardt wrote:
> > | I'm using gnucash for a small business and now I'm trying to figure out
> > | a better way to handle payroll withholding taxes.  Right now, I have
> > | Liability / Accounts Payable / Taxes / Federal / Employer and Employee
> > | accounts - that works out pretty well for me to pay the tax man each
> > | quarter.  I expense the Employer tax contributions so it's pretty simple
> > | to see what is paid out from the company's perspective.  However, I'm
> > | having problems on how to deal with the employee withholding taxes.
> > |
> > | I can't expense them - since they're not an expense to the company.  The
> > | liability goes down to $0 after I pay off each quarter.
> >
> > This is correct.

yes indeed, this *is* correct.
> 
> I would query this.
> 
> Who pays these taxes? 

The employee pays them. They are _*not*_ an expense of the business. 

> I know they are withheld from the employee's salary, but 
> ultimately the combination of employee's salary and any withholdings is, 
> surely, an expense to the business.

no. you're conflating two different things here. The employer has
exactly two types of expenses associated with payroll (US here): 

1) the employee's *gross* pay be it salary, hourly, piecework, whatever;
2) the employer's share of any required payments such as FICA, MCare,
workers comp, unemployment etc. 

We'll ignore for now things like IRA's, pensions, health insurance
etc., though they are handled in the same way.

The tax that is withheld from the employee's *gross* pay is the
*employee's* money and the expense is theirs as well. You are just
keeping part of it for them and sending it to the appropriate agency
for them. In fact, employee's should be recording their paychecks in
the same way: gross income, payroll tax expense, net deposit. 

Now it is possible to record as payroll expense the net pay, and then
record as payroll-tax expense the two sides of shared withholdings and
end up at the same gross expense. It's a semantic but important
difference. What is happening is that the calculation of withholding
is happening off the books and being shuffled into a different
expense account. 

Here is how that looks:

Wrong way --

Gross payroll expense	$8.00
Employee tax expense	$2.00
Employer tax expense	$2.00
Total expense		$12.00

And there is a paycheck with a single split to payroll expense

Joe Employee 
    Payroll expense	$8.00	
    Checking Acct		$8.00

The right way --

Gross payroll expense	$10.00
Employer tax expense	$2.00
Total expense		$12.00

and the paycheck looks like this:

Joe Employee
    Payroll expense	$10.00
    Employer Tax exp.	$2.00
    Payroll Liability		$4.00
    Checking Acct		$8.00

you could split the Payroll liability into separate accounts if you
want, one for employee, and one for employer, but that's a
preference. 

Do you see how the employer, in the second scenario doesn't care what
the employee's expenses are? The employer just pays the employee $10
and says do with it what you will. In the US, the employee could
actually direct the employer to withhold *no tax* and that could be
done (ignoring potential regulatory problems). So the amount of tax
that is withheld by the employer is controlled by the employee (for
certain definitions of control) and is only held on the employee's
behalf by the employer.

Why record it this way?

1) because if you want to know what your labor cost is, you can now
see that by looking at Payroll expense without having to add back in
the Employee tax expense. Imagine this scenario: you run a business in
two different jurisdictions with different local income tax rates. How
do you accurately compare those two businesses' payrolls? In terms of
how the businesses are performing, meeting goals, whatever, you cannot
really compare if the local taxes (which your managers have no control
over) are part of the equation.

2) You can see what your payroll tax expense is without worrying about
whether that includes employee paid amounts or not.

3) It reflects reality. Accountants will always tell you that the
books should reflect reality as much as possible.


> The fact that the liability gos to zero 
> when the contributions are paid doesn't mean it's not an expense. Surely the 
> same happens with every bill you have (unless you don't pay you
> bills).

Irrelevant. The movement of money to and from a liability has nothing
to do with expenses. I could borrow money from you, record my new
liability and then pay it back to you (interest free of course ;),
record the payment of that liability, and *never* have an expense
touch any of those txns. This is exactly what happens when payroll
taxes are withheld and then paid. The money is "borrowed" from the
employee, held by the employer until some date and then paid by the
employer to the govt. There is no expense involved (on the employee
tax side) for the employer. 

> 
> >
> > | How would I enter it so that I could just run a report out of
> > | gnucash to get the employee withholding amounts?
> >
> > One option would be to see if half of the Cash Flow report gives you
> > what you want.  All of the credits to Liability/.../Employee is the
> > amount withheld.  Just ignore the debits half of the report.
> >
> > Another option would be to add a sub-account under "Salaries Expense"
> > for "Employees' Taxes Withheld".  Then when you record the payroll,
> > you can note the tax withholding separately.  The total (including the
> > sub-account) of Salaries Expense would show your company's actual
> > expense, and the sub-account would show your employees' expense.
> 
> This is pretty much what I do. My approach (which is based around UK payroll, 
> but I can't see any major difference) is to treat the withholdings and the 
> net salary both as expenses. Each salary period these both get posted to 
> Accounts Payable (because they are owing). Then there's a transfer from the 
> Bank Account to Accounts Payable to mirror the net salary payment to the 
> employee.

You should put the withheld amounts in a Liability account with the
other split coming from a reduction of the gross payroll. see above. 

> 
> When the whitholding is due, there's another payment from the bank account to 
> the IRS (or whoever) to reflect this payment.
> 
> I made another posting recently "Payroll (UK specific)" which describes how to 
> use a scheduled transaction to make this easier.
> 
> In my case I'm using an account tree which is:
> Expenses
>  |- Emoluments
>      |- Employee1
>          |- Net Salary
>          |- Withholdings
>      |- Employee2
>          |- Net Salary
>          |- Withholdings


Expenses
 |-Emoluments (? what's that word mean?)
    |-Employee 1 Salary
    |-Employee 2 Salary

Liabilities
 |-Payroll Liab,
   |-Employee1 
   |-Employee2 
   |-Employer

this is not great. below is better.

> etc.
> 
> It may be better (and I am considering changing my account tree to this) to 
> have:
> Expenses
>  |- Emoluments
>     |- Net Salaries
>        |- Employee1
>        |- Employee2
>     |- Withholdings
>        |- Employee1
>        |- Employee2


Expenses
 |-Emoluments (? what's that word mean?)
    |-Management
       |-Employee1
       |-Emlpoyee2
    |-Service Labor
       |-EMployee3
       |-Employee4

Liabilities
 |-Payroll Liab,
    |-Federal Tax
       |-Employee1
       |-Employee2
       |-Employee3
       |-Employee4
       |-Employer
    |-FICA tax
       |-Employee1
       |-Emlpoyee2
       |-Employee3
       |-Employee4
       |-Employer

> 
> This would give you the ability to see the total Withholdings for a period in 
> the account tree. It's also possible there's some good reports that can be 
> derived from this.

using the above, a balance sheet shows what is owed at any given
time. A cashflow report (limited to the payroll liability accounts
only) will show how mouch money flowed into those liabilities on a
particular day. I use that to determine how much money to escrow after
a payroll. works great.

regards.

A
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