Payroll Accounting Explained: Withholdings, Employer Taxes, and Journal Entries

Payroll is one of the largest expenses for most businesses and one of the most compliance-heavy areas of accounting. Students often underestimate its complexity until they see the full set of journal entries required — which involve multiple employee withholdings, employer matching obligations, and several separate liability accounts. This guide covers everything from gross pay to the final payment, with complete journal entries at each step.

Gross Pay vs Net Pay

The distinction between gross pay and net pay is the starting point for all payroll accounting. Gross pay is the total compensation earned by the employee — hourly rate times hours worked, or the agreed salary for the period — before any deductions. Net pay (the "take-home" amount) is gross pay minus all withholdings — the actual amount the employee receives.

The payroll accounting process records the full gross pay as a wage expense, then separately records each withholding as a liability the employer owes on behalf of the employee (to the government, to benefits providers, etc.). The difference — net pay — is what is owed to the employee. This is an important conceptual point: the employer is acting as a collection agent for the government when it withholds income taxes and payroll taxes from employee pay.

Employee Withholdings Explained

Federal Income Tax (FIT) Withholding — Based on each employee's Form W-4 (withholding allowances and filing status). The employer withholds the appropriate amount from each paycheck and remits it to the IRS on a regular schedule. This is an employee expense — it reduces the employee's paycheck but creates a liability for the employer until remitted.

Social Security Tax (OASDI) — The employee pays 6.2% of gross wages up to the annual Social Security wage base (which adjusts annually — $168,600 for 2024). The employer also pays 6.2%, making the combined rate 12.4%. Both the employee's share (withheld from pay) and the employer's share (additional employer cost) must be remitted together.

Medicare Tax (HI) — The employee pays 1.45% of all wages with no wage ceiling. The employer matches this 1.45%. High earners pay an additional 0.9% Medicare surtax above $200,000 (single) or $250,000 (married) — but the employer does not match this additional surtax.

State Income Tax (SIT) — Varies by state. Some states have no income tax; others have rates from 2% to over 10%.

Voluntary deductions — Health insurance premiums, dental and vision, retirement plan contributions (401k), and similar employee elections are withheld from gross pay and remitted to the appropriate providers. Pre-tax deductions (like traditional 401k contributions and health insurance premiums under a Section 125 plan) reduce the employee's taxable income.

Employer Payroll Tax Obligations

The employer not only withholds the employee's share of FICA (Social Security and Medicare) but also pays a matching contribution entirely out of employer funds — these are an additional cost of employment beyond the employee's gross pay. Federal Unemployment Tax (FUTA) and State Unemployment Tax (SUTA) are also entirely employer-paid obligations.

Employer Payroll Tax Summary

Tax	Employee Pays	Employer Pays	Wage Ceiling
Social Security (OASDI)	6.2%	6.2%	Annual wage base
Medicare (HI)	1.45%	1.45%	No ceiling
FUTA	0%	0.6%*	$7,000
SUTA	0%	Varies by state	Varies

*FUTA rate after the maximum 5.4% state credit; gross FUTA rate is 6.0%

Journal Entry 1: Recording the Payroll

Using an example: A company has total gross payroll of $100,000 for the month. Federal income tax withheld: $18,000. Employee Social Security (6.2%): $6,200. Employee Medicare (1.45%): $1,450. Employee health insurance premiums: $2,000. Net pay to employees: $72,350.

Entry 1 — Payroll Expense and Liabilities

DEBIT Wages Expense $100,000
CREDIT Federal Income Tax Payable $18,000
CREDIT Social Security Tax Payable $6,200 (employee share)
CREDIT Medicare Tax Payable $1,450 (employee share)
CREDIT Employee Health Insurance Payable $2,000
CREDIT Salaries Payable $72,350

Journal Entry 2: Employer Payroll Taxes

The employer records its own matching FICA obligations as a separate expense. Employer Social Security (6.2% × $100,000): $6,200. Employer Medicare (1.45% × $100,000): $1,450. FUTA (0.6% × $7,000 per employee — assuming 10 employees all under the wage base): $420. SUTA (assume 3.5% × first $10,000 per employee — 10 employees): $3,500.

Entry 2 — Employer Payroll Taxes

DEBIT Payroll Tax Expense $11,570
CREDIT Social Security Tax Payable $6,200 (employer share)
CREDIT Medicare Tax Payable $1,450 (employer share)
CREDIT FUTA Tax Payable $420
CREDIT SUTA Tax Payable $3,500

Journal Entry 3: Paying the Payroll

Entry 3 — Direct Deposit to Employees

DEBIT Salaries Payable $72,350
CREDIT Cash $72,350

Journal Entry 4: Paying Taxes to Government

FICA taxes (employee + employer shares) and federal income tax are deposited with the IRS together, typically semi-weekly or monthly depending on the employer's deposit schedule.

Entry 4 — FICA and FIT Deposit to IRS

DEBIT Federal Income Tax Payable $18,000
DEBIT Social Security Tax Payable $12,400 ($6,200 × 2)
DEBIT Medicare Tax Payable $2,900 ($1,450 × 2)
CREDIT Cash $33,300

Payroll Compliance Obligations

Payroll compliance involves numerous deadlines and forms. Form 941 (Employer's Quarterly Federal Tax Return) is filed quarterly. Form 940 (Annual FUTA Return) is filed annually. Form W-2 (Wage and Tax Statement) is issued to each employee by 31 January. Form W-3 transmits the W-2s to the Social Security Administration. Late deposits trigger significant penalties — payroll tax deposits are one of the most strictly enforced areas of IRS compliance. Practise payroll accounting questions on PrepQBank to build fluency with these calculations.

📌 Key Distinction: Employee vs Employer Taxes

Employee taxes are withheld from the employee's pay — they reduce net pay. Employer taxes are an additional cost paid by the employer from its own funds — they are on top of gross wages. Both appear as liabilities until remitted, but only the employer taxes create additional payroll tax expense beyond wages expense.

Practice Payroll Accounting Questions

PrepQBank covers payroll withholdings, employer payroll taxes, and all four payroll journal entries with adaptive questions and step-by-step explanations.

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