Income and Social Security Taxes
When the employees of a business are paid wages, it becomes mandatory for the business to withhold a certain segment of the employee’s gross salary to cover income and Social Security taxes. Social Security taxes can be bifurcated into FICA and Medicare. The rate of Medicare taxes is 1.45% of the gross salary while that of FICA is 6.2% and is capped at an amount that varies every year. $94,200 was the capped amount in 2006. Moreover, the employer is bound to pay a dollar for dollar match for every dollar of Medicare and FICA taxes that are withheld. This implies that the Federal Government gets 2.9% of the total gross salary in Medicare and 12.4% of the gross salary to the ceiling amount that is fixed on year to year basis.
Amount to be withheld from employee’s salary
In addition, the employer has to withhold from an employee’s gross salary an amount to cover the anticipated amount of federal income taxes the employee will be liable to pay for a year. Typically, the amount withheld corresponds to the amount and frequency of gross salary payments as well as the filing status of the individual employee and the number of personal exemptions claimed on his or her income tax return.
State and local jurisdictions
Along with these Federal income and social security taxes, state and local jurisdictions generally impose some form of income tax and require that employees withhold an amount from their gross salary to meet these liabilities. The amount of these withheld amounts for the purpose of paying taxes also depends on the frequency and amount of gross salary.
Reserve fund for unemployment insurance
Also, the Federal Government and the local and state jurisdictions require that the employer pay into a reserve fund for unemployment insurance. This amount, typically, is not withheld from the employee’s gross salary but is imposed on the employer based on certain rates fixed by the state jurisdiction and the balance in the employer’s reserve account.
There is a difference between the taxes that are withheld from an employee’s gross salary and those that are to be paid by the business owner above the amount of gross salary. Employment taxes are the employer’s match of Social Security taxes and the unemployment taxes to be deposited to the unemployment reserve account and they consist of an expenditure above and beyond gross payroll payments. The liabilities for both withholding and payroll taxes should be recorded when payroll checks are issued in accrual based accounting.
Here is an example. Joint Ventures hires a pilot, Stephen Fleming to fly some of deliveries. After completion of a couple of flights, he is owed a salary of $1,000. Assume the following payroll tax withholdings and payroll tax liabilities associated with the gross payroll.
This is the entry recorded once the payroll check is issued.
Observe that there is no expense related to payroll taxes withheld. The complete expenditure is shown in gross salary. Keep in mind that there are two entries required at the time the payroll check is issued. One of the entries reflects the gross payroll and withholdings while the other one records the employer’s payroll tax liability.
Special Liability for Employers
The payment of withheld taxes portrays a very special kind of liability for business owners. If an employee’s gross salary has been subject to tax withholdings, then the employee is credited by the government with the taxes paid whether or not the employer actually pays the withheld taxes to the government. Since the taxes withheld to the employer must be credited by the government, when a business owner fails to pay the withheld taxes to the government, it transpires into a situation wherein an unsanctioned loan is being given to the employer and the government does not fancy making unsanctioned loans.
Therefore, there are steep penalties in place if an employer fails to turn over withheld or other payroll taxes. Moreover, unpaid withheld payroll taxes cannot be discharged in bankruptcy in contrast to other debts and conventional income tax liabilities.
The amount of money owed determines the timing for paying withheld taxes and other payroll taxes. The greater the amount that an employer is owed, the shorter is the time period in which to turn over the required amount to the government. This is the entry for payment of the payroll withholding and taxes.