Lesson 40 - Beginner accounting course

40. Payroll Deductions and Employer Contributions

Payroll deductions and employer contributions are fundamental aspects of payroll accounting. Businesses must properly track and report these deductions to ensure compliance with labor laws, tax regulations, and employee benefit agreements. Payroll deductions reduce an employee's gross pay to determine their net pay, while employer contributions represent additional expenses incurred by the company in relation to payroll.

Understanding how these deductions and contributions function is crucial for maintaining accurate financial records and ensuring that employees receive their correct wages.

Types of Payroll Deductions

Payroll deductions fall into two main categories: mandatory deductions, required by law, and voluntary deductions, which employees choose to have withheld from their paycheck.

Mandatory Payroll Deductions

These are deductions required by federal, state, or local laws. They include:

• Federal Income Tax – Withheld based on the employee’s income level and tax bracket.

• State and Local Income Taxes – Some states and municipalities impose additional income tax deductions.

• Social Security Tax (FICA – Federal Insurance Contributions Act) – Employers must withhold 6.2% of an employee’s wages for Social Security, up to an annual wage limit.

• Medicare Tax – A 1.45% tax is withheld from all wages to fund Medicare. Employees earning above a certain threshold must also pay an additional 0.9% in Medicare tax.

• Wage Garnishments – Court-ordered deductions for unpaid debts, child support, or tax obligations.

Voluntary Payroll Deductions

Employees may opt into certain deductions based on their individual needs or employer offerings. These include:

• Retirement Contributions – Contributions to 401(k) plans, pensions, or IRAs.

• Health, Dental, and Vision Insurance Premiums – Employees pay for a portion of their insurance coverage.

• Flexible Spending Accounts (FSA) and Health Savings Accounts (HSA) – Contributions for medical or dependent care expenses.

• Union Dues – Payments required for employees who are part of a labor union.

• Charitable Contributions – Some employers allow employees to contribute to charitable organizations directly through payroll deductions.

Voluntary deductions must be properly authorized by employees and managed to ensure compliance with payroll policies.

Employer Payroll Contributions

In addition to deducting money from employees’ paychecks, employers must contribute additional funds to cover payroll-related expenses. These employer-paid contributions are essential costs of employing workers and must be recorded accurately.

Common Employer Payroll Contributions:

• Social Security and Medicare Taxes (FICA Matching) – Employers must match the 6.2% Social Security tax and the 1.45% Medicare tax paid by employees.

• Federal and State Unemployment Taxes (FUTA and SUTA) – Employers pay a percentage of each employee's wages to fund unemployment benefits. FUTA is a federal tax, while SUTA varies by state.

• Workers’ Compensation Insurance – Some states require employers to carry workers’ compensation insurance to cover job-related injuries or illnesses.

• Health Insurance Premium Contributions – Many employers pay a portion of employee health insurance premiums.

• Retirement Plan Contributions – Employers may contribute to 401(k) or pension plans as part of employee benefits.

These contributions increase the employer’s total payroll expense and must be accounted for accurately in financial records.

Recording Payroll Deductions and Employer Contributions

When payroll is processed, accountants record gross wages, withholdings, employer contributions, and final net pay. These transactions are recorded in the general ledger using journal entries.

Example Payroll Journal Entry

Assume a company pays an employee a gross salary of $5,000. The payroll deductions and employer contributions are as follows:

This journal entry accounts for:

1. Employee's Gross Pay ($5,000)

2. Employee Payroll Deductions ($1,332.50 total)

3. Net Pay (Cash Payment to Employee) ($3,667.50)

4. Employer Payroll Contributions ($382.50)

The employer must remit all withheld amounts to government agencies and benefit providers.

Key Takeaways

• Payroll deductions reduce an employee’s wages and include taxes, benefits, and retirement contributions.

• Employer contributions are additional costs paid by the employer, such as Social Security matching and unemployment taxes.

• Accurate payroll accounting ensures compliance with tax laws and financial accuracy.

• Proper journal entries help track payroll transactions and ensure liabilities are paid on time.

Understanding payroll deductions and employer contributions is crucial for any business, ensuring compliance, accurate financial reporting, and smooth payroll processing.