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How to Run a Smarter Payroll

Running payroll involves a lot of details

Posted Jul 31, 2018

In our previous post, Smart Payroll: Setting it Up Well, we gave you tips on how to structure and implement an efficient payroll process that benefits both your team and your business.  Now we’ll cover some questions that can come up as you run your payroll system.

Some are common questions that you or your employees may want to understand about their pay. Others may be uncommon topics, but things you’ll be glad you know should the need arise.

What’s the Difference Between Income Tax and Payroll Tax?

There are two different types of taxes applied to an employee’s pay – income tax and payroll tax.

Income tax encompasses federal, state, and even local income taxes. These are based on an employee’s income level and the withholding allowances that they declared on the W-4 form (and in some cases a state withholding form for state taxes) they completed when hired.

To figure federal income tax, you’ll use IRS Publication 15. Based on the allowances claimed in their W4 and their weekly wages, you can determine their federal deduction, which makes the number variable and unique for each employee. State and local income taxes are computed in a similar way.

Payroll taxes, however, are not variable. These taxes, also known as the Federal Insurance Contributions Act (FICA) tax, are used to fund Social Security and Medicare. FICA is the same percentage for every employee – 7.65%. The employer also contributes 7.65% as a “match” of what is taken out of the employee’s pay.   For instance, if an employee earns $1000 per paycheck, they would owe $76.50 in FICA tax. You, as the employer, would also owe $76.50 for this employee.

FICA has two components – Social Security and Medicare.  Of the 7.65% total assessment, 6.2% goes to funding the Social Security Administration and 1.45% goes towards funding Medicare.

This is important to note because there is a salary cap at which the Social Security component is no longer charged.  For 2018, that 6.2% for Social Security is only charged on an employee’s first $128,400 of earnings.  Any income above that is only required to continue paying the Medicare component of 1.45%.  So you and your higher income earners get some tax relief after a certain level.

Payroll Management and State & Local Income Taxes

It should be noted that most states and some local governments also levy income tax. And it can be as a percentage of income or a recurring set dollar amount.  Only seven states don’t require employers to collect income tax, so it’s likely that you’ll need to collect this. Several states also require an employer to withhold unemployment insurance, and a very limited number require a disability insurance withholding as well.

Local income taxes may come in the form of a permanent tax or a short-term tax to fund specific projects or other purposes. Local taxes have great variation, so be aware.

You may want to consult a tax professional if you have any questions at all about either state or local taxing requirements.

Where Should Paychecks and Payroll Distributions be Recorded?

Paychecks and distributions recording can get complex and must be accurate to ensure you’re accounting not just for the costs of labor – such as salary, wages, and tips – but for the tax liability as well.

Initially, you’ll record the “cost of labor” (employee earnings). Converting labor into costs can be done with a large journal entry that includes a credit for the gross wages and debits for things like Paid Time Off (PTO) and hours worked.

Payroll taxes are a liability the company carries until the taxes are paid and should be credited to the appropriate liabilities account – such as accrued salary liabilities or payroll tax liabilities account. Income and FICA taxes are paid annually, quarterly, monthly, and semi-weekly, depending on how you are directed to pay by the IRS.

Accurate recording of paychecks and tax liabilities is an important piece of your business. It’s worthwhile to consider bringing in expert help to ensure that you’re properly crediting and debiting your accounts.

How Long is a Payroll Check Good For?

It may sound silly, but that question does come up from time to time.

Many payroll checks have an expiration notice on them, something that indicates that a check is void if not cashed within 90 days, sometimes longer. However, that doesn’t mean that a bank won’t honor the check. There isn’t really a hard and fast rule about when a check expires.

The standard set of business laws for financial concerns, the Uniform Commercial Code (UCC), states that a bank doesn’t have to accept a check that is more than 6 months old. But a bank can, in fact, cash a check older than that at their discretion.

If a check is not cashed in the 6-month time frame, and a bank will no longer accept the check, the U.S. Department of Labor requires employers to provide back pay to employees for up to two years. Employers are required to keep payroll records for three years, so you should be able to locate records for a check if an employee should request a replacement.

If you’re concerned about getting the uncashed check off of your books, you can present the check to the state as unclaimed property after one year. This would require the employee to contact the state to receive their funds.

Keep in mind that state and federal tax laws change frequently. Be sure to keep your accounting and payroll software current on any updates, as most software programs push out updates to accommodate the changes as soon as they go into effect.

The IRS and state income tax agencies keep the documentation on their websites current with any changes. You may want to schedule regular visits to see what’s new.  You can also consider signing up with the American Institute of CPAs (AICPA) for their newsletter, where they detail pertinent tax changes and their impact.

Another way to stay current with ongoing tax code changes is to outsource your Payroll management to a third-party. Certain accountants and payroll firms manage smaller businesses’ payroll quite easily and cost-effectively. Leaving all this hassle to them can free up a lot of hours you can use to grow your business.  Something to think about!

If your payroll is becoming more time-consuming and distracting you
from running your business, give us a call.  
Simpay takes the complete payroll process off your desk and makes it our responsibility.
Call Andrew at 866-253-2227 to learn how.