Managing the Payroll – Calculating Take-Home Pay
The ﬁrst step in ﬁguring out take-home pay is calculating the gross pay, which is how much the employee has earned during the pay period. For salaried employees, getting to this number is a piece of cake—it’s the same as last time (unless you’ve handed out raises). When you pay your employees in any other way, such as hourly or on a commission basis, you’ll need to do a little math to come up with their current gross pay.
When you start to pay employees, know what your state minimum wage is. The federal minimum wage rate is $5.15 per hour (or $206 for a forty-hour weekly salary). Some states have higher minimum wage rates. When the federal and state rates are different, you have to pay whichever is higher.
Let’s take a brief look at what counts as taxable compensation, regard- less of how you pay your employees. Most of the payroll laws refer to wages as an all-encompassing category. It includes what you think of as wages (hourly pay), ﬁxed salaries, pay for piecework, overtime pay, bonuses, com- missions—pretty much any label you could put on employee earnings, what- ever scale they are based on. It doesn’t matter if it’s extra compensation above and beyond the normal salary; it doesn’t even matter if you don’t pay your employees in money (you could pay them in shoes, French fries, or legal services). Anything you give an employee in exchange for work they’ve done counts as taxable compensation.
On the ﬂip side, there are plenty of things that seem like compensation that do not count as taxable when you’re ﬁguring out the payroll taxes.
These include things such as:
- Loans to employees
- Expense reimbursements
- Nontaxable beneﬁts (such as employer-paid health insurance)
- Gifts and awards
Then, as in most things that have to do with taxes, there are gray areas in which compensation being taxable or not depends on circumstances. These gray areas include things such as tips, advances against future earnings, and vacation pay.
Calculating Withholding Taxes
Every time you pay your employees, you have to take out taxes; you can’t just give them gross pay for three weeks and take out a bigger lump of taxes in week four, for example. The tax amounts will be different for each employee, and maybe even for the same employee over different periods. The income tax you withhold for each employee throughout the year is supposed to come very close to what his full-year liability would be, and that depends on several unique factors. Your responsibility is limited to with- holding taxes based on the information he gave you when he ﬁlled out his most recent W-4.
It sounds really tough, but isn’t as bad as it seems. The IRS has detailed withholding tables you can use to look up how much income tax to deduct for each employee. You can get a free copy of the standard tables by calling the IRS (at 1-800-TAX-FORM) and requesting a copy of Publication 15.
If you are using payroll software, it’s even easier because the tables are built right in. All you have to do is enter each employee’s wage and allowance information.
FICA taxes (the combined name for Social Security and Medicare), though, are two standard percentages multiplied by the gross pay, unchanging until an employee hits the $90,000 (as of 2005) Social Security tax limit.
For the Social Security portion, the rate is 6.2 percent; you multiply that by the employee’s gross pay. When his pay hits the $90,000 cap, you don’t have to withhold Social Security taxes any more. The Medicare portion has no wage limit. You simply multiply employee wages by 1.45 percent and with- hold that amount all year long.
There are several states that do not have a personal income tax on the books, so employers in those states don’t have to withhold state income taxes. The no-withholding states are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.
As for state and local income taxes, the process is pretty much the same. You simply contact your state ofﬁce of taxation to get a copy of its payroll tax rules. In those guidelines you will also ﬁnd the rules for employees who live in one state and work in another. Sometimes you have to take out taxes for both states, sometimes only one, so check with your state tax ofﬁce to ﬁnd out which you have to do. Some states also impose an unemployment or a disability insurance tax on employees, usually a tiny ﬁxed amount every pay period (such as $5, or 0.5 percent).
Dealing with Other Deductions
Once you are done with the withholding taxes, the next set of subtractions is considered voluntary deductions. These are items that the employee actually chooses to have taken directly out of his paycheck. It’s up to you as the employer to decide whether you will offer these programs for the convenience of your employees. A large number of employers offer the two most common: retirement plan contributions and health insurance premiums.
Other work-related deductions, again done for the convenience of the employee, include things such as union dues, uniform purchases and cleaning, and parking. Deductions are not always limited to work-related items, though. Some employers will take out anything from charitable contributions to U.S. savings bond purchases. Again, it’s your choice which of these voluntary deductions will be available to your employees. When you do offer them, you have to honor them, even if that becomes inconvenient.
An Example with Numbers
For this example, you have one employee, Joe Block. Joe is single and claimed no exemptions on his Form W-4. Your company is located in Ohio, where Joe lives. You pay Joe a steady salary of $300 per week. There are no voluntary deductions taken out of Joe’s paycheck.
According to the standard federal income tax tables (for 2006), you withhold $31 from Joe’s paycheck every week. Based on the 2006 withholding tax tables for Ohio, you take out $6.42 for state income taxes. His Social Security tax comes to $18.60, which is $300 times 6.2 percent. His Medicare tax is $4.35, calculated by multiplying $300 by 1.45 percent. Once you subtract all the withholding taxes from Joe’s gross weekly salary, you come up with his net take-home pay of $239.63. That will be the amount of his paycheck; on his pay stub, you will list every amount withheld from his gross pay.
The Journal Entries
Now that you have completed the actual paycheck portion of the pay- roll, you have to record the transactions in your payroll journal. The ﬁrst transaction records the payroll itself. If you have only one employee, the journal entry will mirror his pay information. When you have more than one employee, your journal entry will be a summary of the totals for all employees. (Note: In the example below, the FICA Payable entry includes $18.60 for Social Security and $4.35 for Medicare.)
Payroll Journal Entry 1
|January 13, 2006|
|Federal Income Tax Payable||$31.00|
|State Income Tax Payable||$6.42|
To record payroll for the week ending January 13, 2006.
Payroll Journal Entry 2
|January 13, 2006|
|Payroll Tax Expense||$41.55|
To record the employer portion of payroll taxes for the week ending January 13, 2006.
A second transaction entry is also necessary so you can record the employer tax obligations for this payroll period. The taxes involved in this journal entry include the employer matching contributions to Social Security and Medicare, any employer-based state taxes (such as unemployment), and federal unemployment taxes. Continuing with the example from the previous section, the employer portion of FICA would equal exactly the amounts withheld from Joe’s paycheck, which came to a total of $22.95 ($18.60 plus $4.35). Since the company does not have to pay state unemployment taxes, it has to pay the full amount of FUT, which comes to $18.60 ($300 times 6.2 percent).
Those two journal entries take care of recording the payroll for the period. As you can see, only Joe’s net pay is credited to the cash account. That’s because it’s the only amount actually paid at this time. Both the withholding taxes and employer taxes will be paid later on, when you ﬁle your payroll tax returns. At that time, you will debit the various tax payable accounts and credit your cash account, just like any other regular cash disbursement.