Payroll Liabilities
Wages, taxes, withholdings, and the true cost of an employee.
Why This Matters
Payroll looks simple: employees work, you pay them.
But what actually flows through a payroll entry is far more complex. An employee earns $3,000. You don't just write them a $3,000 check — you withhold federal income tax, state income tax, Social Security, Medicare, and possibly health insurance or retirement contributions. You also owe additional payroll taxes as the employer, on top of what you paid in gross wages.
The Multi-Liability Nightmare
By the time payroll is done, you've created multiple liabilities to multiple parties — employees (for net pay), the IRS (for withheld taxes), the state (for state taxes), and benefit providers — all due at different times.Mess this up and the consequences are serious: payroll tax penalties are steep, employees don't trust you, and the IRS has zero tolerance for late payroll tax deposits.
Payroll liabilities are the most technically involved current liabilities you'll encounter. Master them, and you'll understand how a single $3,000 paycheck becomes a multi-account journal entry affecting six or more accounts at once.
The Payroll Ecosystem
Before diving into entries, you need to understand the key players and what each is owed.
- • Federal income tax withheld from employee
- • Employee's share of Social Security (6.2%)
- • Employee's share of Medicare (1.45%)
- • EMPLOYER's share of Social Security (6.2%) ← Employer cost
- • EMPLOYER's share of Medicare (1.45%) ← Employer cost
- • Federal unemployment tax (FUTA) ← Employer cost
- • State income tax withheld from employee
- • State unemployment tax (SUTA) ← Employer cost
- • Health insurance premiums withheld
- • 401(k) contributions withheld
- • Other voluntary deductions
Key Payroll Terms
| Term | Definition |
|---|---|
| Gross Wages | Total earnings before any deductions |
| Net Pay | What the employee actually takes home (gross - deductions) |
| Withholdings | Amounts deducted from employee pay on behalf of government/benefits providers |
| FICA Taxes | Federal Insurance Contributions Act — Social Security + Medicare |
| Social Security | 6.2% withheld from EE + 6.2% paid by ER (on wages up to $168,600/yr) |
| Medicare | 1.45% withheld from EE + 1.45% paid by ER (no wage cap) |
| FUTA | Federal Unemployment Tax Act — employer pays 0.6% on first $7,000 |
| SUTA | State Unemployment Tax Act — employer pays, rate varies by state |
| W-4 | Employee form that determines federal withholding |
The 5-Step Payroll Process
Calculate the Payroll
ABC Coffee Shop has one full-time employee: Sarah. Let's calculate her January net pay.
Record the Payroll Entry (Employee Withholdings)
This entry records all liabilities created from the employee's gross wages.
Date: Jan 31, 2026
Record the Employer Payroll Tax Entry
This is where most students get tripped up: the employer also owes payroll taxes — separate from and in addition to what was withheld from the employee.
| Tax | Rate | Amount |
|---|---|---|
| Social Security (ER) | 6.2% of gross | $248 |
| Medicare (ER) | 1.45% of gross | $58 |
| FUTA (Federal Unemployment) | 0.6% of first $7k | $24 |
| SUTA (State Unemployment) | 2.7% (varies) | $108 |
| Total Employer Taxes | $438 | |
Date: Jan 31, 2026
The True Cost of an Employee
Employee Sees:
$2,854
Net Pay (Take-home)
Employer Pays:
$4,638
Gross + ER Taxes + Benefits
Sarah thinks she costs the company $2,854. The company actually pays $4,638 to employ her. That's 63% more than her take-home pay.
Record the Cash Payment to the Employee
On payday (Feb 5), ABC actually pays Sarah her net pay.
Date: Feb 5, 2026
Remit Taxes to the Government
Payroll taxes must be deposited with the IRS on specific schedules. Notice how SS and Medicare combine the EE and ER shares.
Date: Feb 15, 2026 (IRS Deadline)
The Full Payroll Picture: T-Accounts
Wages Expense
Wages Payable
Social Security Tax Payable
Federal Income Tax Payable
Real-World Output: Balance Sheet
Here is how all of these liabilities look on the balance sheet immediately after the January 31 entries are made (before any February payments).
ABC COFFEE SHOP
Balance Sheet (Partial)
As of January 31, 2026
CURRENT LIABILITIES
Common Mistakes
Mistake 1: Forgetting the Employer's Share of FICA
Only recording employee withholdings.
Result: Missing additional Social Security and Medicare expense.
Make TWO separate entries:
- Payroll entry (EE withholdings)
- Employer tax entry (ER's FICA + FUTA/SUTA)
Mistake 2: Debiting Wages Expense for Net Pay
Wages Expense 2,854 ← Net Pay
Cash 2,854
Wages Expense 4,000 ← Gross
(Various liabilities)
The company's EXPENSE is the gross wage. Withholdings are intermediary liabilities.
Key Takeaway
Payroll liabilities arise from two sources: amounts withheld from employee wages (federal/state income taxes, employee FICA) and additional employer-paid taxes (employer FICA, FUTA, SUTA).
These are recorded in two separate journal entries. The expense recorded is the full gross wage plus employer taxes — never the net pay. All payroll liabilities are current liabilities settled by the next remittance deadline.
Test Your Understanding
See if you've got the basics down. Click each option and check your answer.
Question 1: An employee earns $5,000 in gross wages. Federal income tax withheld is $600. Social Security withheld is $310. Medicare withheld is $72.50. What is the employee's net pay?
Question 2: In the payroll journal entry, Wages Expense is debited for:
Question 3: An employee earns $3,000 in gross wages. Employer Social Security rate is 6.2% and Medicare is 1.45%. What is the total Payroll Tax Expense the employer records?
Question 4: Which of the following correctly lists all liabilities created by a $2,000 payroll with $300 federal tax withheld, $40 Social Security withheld, $9.50 Medicare withheld?
Question 5: True or False: FUTA and SUTA are withheld from employee wages.
Ready to Practice?
You now understand one of the most complex journal entries in accounting. The Practice Lab challenges you to calculate gross-to-net pay, record payroll entries, and simulate remitting taxes.
Try the Practice LabWhat's Next?
You've now completed the Current Liabilities unit! Coming up next: Long-Term Liabilities (notes payable, bonds, and mortgages).