Breaking Down the Thrilling World of Payroll Journal Entries

Mackenzie Patel
Mackenzie Patel
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October 24, 2023

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Breaking Down the Thrilling World of Payroll Journal Entries

October 24, 2023
Technical Accounting

One of the most omnipresent and iconic accounting processes of a modern day business is payroll. Calculating and remitting payroll taxes and net employee wages can be a daunting black box, especially with arbitrary withholding percentages and IRS forms floating around. Fortunately, employers have a suite of payroll softwares that automates the hard work around paying their employees. Whether it's traditional softwares like Gusto or Rippling or crypto-native ones like Franklin or Niural, these tools simplify payroll so founders can start paying their employees ASAP.

There’s already a litany of articles about Payroll 101, so this piece will focus on the accounting side and how to decipher the journal entry that your payroll provider is syncing into Quickbooks. The first time I saw an entry synced directly from Rippling, I was slightly bewildered. These softwares provide no decoding mechanism and only give accountants a measly “cash requirements” report. I was searching for a line-by-line explanation for each entry and how the number was calculated. After hours of research (and a bundle of queries on Perplexity AI), I decrypted the payroll hieroglyphics.

To dive in, here’s an example entry synced from Rippling (note: this entry assumes no classes are used in Quickbooks):

# Account Debit Credit Classification Description
1 1000: Cash $xx Current Asset Employee net pay for check date 10/05/2023
2 1000: Cash $xx Current Asset Payroll taxes paid via Rippling for check date 10/05/2023
3 5000: Employee Wages $xx Operating Expense Gross wages
4 5000: Home Office Reimbursements $xx Operating Expense Accountability plan reimbursements
5 5001: Payroll Taxes $xx Operating Expense Employer Medicare Tax
6 5001: Payroll Taxes $xx Operating Expense Social Security
7 5001: Payroll Taxes $xx Operating Expense Federal Unemployment Insurance Tax (FUTA)
8 5001: Payroll Taxes $xx Operating Expense State Unemployment Insurance Tax (SUTA)
9 5002: Health & Other Benefits $xx Operating Expense Medical Deductions (contribution) expense
10 5002: Health & Other Benefits $xx Operating Expense Dental Deductions (contribution) expense
11 5002: Health & Other Benefits $xx Operating Expense Vision (contribution) expense
12 2001: Accrued Payroll Taxes Payable $xx Current Liability SDI Withholding - NY
13 2001: Accrued Payroll Taxes Payable $xx Current Liability FLI Withholding - NY
14 2002: Accrued Benefits $xx Current Liability Medical Deductions (contribution) expense
15 2002: Accrued Benefits $xx Current Liability Dental Deductions (contribution) expense
16 2002: Accrued Benefits $xx Current Liability Vision (contribution) expense
17 2002: Accrued Benefits $xx Current Liability Medical Deductions (deduction) expense
18 2002: Accrued Benefits $xx Current Liability Dental Deductions (deduction) expense
19 2002: Accrued Benefits $xx Current Liability Vision Deductions (deduction) expense
20 2002: Accrued Benefits $xx Current Liability Other Deductions (deduction) expense
21 2002: Accrued 401(k) Payable $xx Current Liability 401(k) (deduction)
Total Entry $xx $xx

Before getting into the guts, there’s a few high-level concepts:

  • The employer is responsible for withholding certain taxes from employee paychecks and remitting them to the IRS on behalf of the employee
    • Think of payroll as a pie - the employer has agreed to pay the employee a base wage, but a portion of the wage is “eaten” by taxes before the net amount trickles down to the employee’s bank account
  • There are taxes that the employer and employee split, such as FICA (social security + medicare)
  • There are taxes that only the employer is responsible for paying, such as federal and state unemployment (some states have exceptions to this, but generally the employer pays)
  • The employer can book a liability without establishing a corresponding expense. This happens when the employer is withholding money on behalf of the employee, but payment is due (to healthcare, other state taxes) outside the payroll software (i.e. Rippling won’t remit the payment on your behalf)

With that, let’s get into each line item!

Current Assets

1 This entry is crediting cash for the net amount that is paid to the employees (gross wages - taxes withheld from the paycheck and deductions). This is typically wired directly from the company’s bank account to the employees, unless they’ve elected to receive a physical check. The full formula is:

net pay = gross pay - all employee taxes withheld - employee benefits deductions
2 This credit to cash represents the payroll taxes that were sent to the IRS. The amount is the sum of payroll taxes paid directly by the employer (i.e. they incurred a new expense) and the payroll taxes withheld from the employee’s paycheck. In our example, the complete breakdown is:
  • Federal Income Tax (employee)
  • Medicare (employee + employer)
  • Social Security (employee + employer)
  • SDI & FLI Withholding (employee)
  • State Withholding (employee)
  • Local Taxes (employee)
  • FUTA (employer)
  • SUTA (employer)
Note: the employee side of taxes won’t show up as an expense on the company’s books because the company isn’t incurring the expense (the employee is!). You can find the employee tax breakdown on the cash requirements or payroll journal report.

Operating Expenses

3 Employee wages is the gross salary for all employees (i.e. the base starting salary that’s included on an offer letter). The company records this full amount as an expense since it’s the total cost of employee compensation.
4 The home office reimbursement is a tax benefit that’s available for owners of C and S corporations who work out of their homes. It’s a subtype of an accountable plan, which the IRS says “allows an employer to reimburse employees on a non-taxable basis when certain requirements are met.” Eligible expenses must meet these requirements:
  • Have a business connection
  • Proof of substantiation (i.e. receipt)
  • Any excess reimbursements must be returned timely
For the home office deduction, the owners receive a nontaxable reimbursement while the company can take a deduction on their tax return for the payment. This nontaxable reimbursement can be set up through your payroll software at a fixed amount (there needs to be adequate documentation of the policy and reimbursement calculation before setting this up). The company records any home office payments as an expense in the period incurred.
5 It’s the first half of FICA: medicare tax! The current medicare tax rate is 2.9%, which means the employer covers 1.45% and the employee also pays 1.45%.

The 1.45% paid by the employer is an additional expense on top of the gross wages already owed to employees.
6 The second half of FICA, the social security tax, works the same way. The total rate is 12.4%, which means the employer and employee both pay 6.2%. Social security tax stops being collected once the wage base limit of $160,200 is met (so the max tax collected from the employee is $9,932 for 2023).
7 - 8 The following two rows revolve around federal and state unemployment taxes. These taxes are owed by the employer and aren't split with the employees (with the exception of Alaska, New Jersey and Pennsylvania, which also withhold SUTA from employee paychecks).

FUTA is only owed on the first $7,000 that is paid to an employee, so the max an employer pays is $420 (the FUTA rate is 6%).
9 - 11 In our example, the company is offering certain health benefits to its employees. Since the employer is contributing to a portion (not all) of the medical, dental and vision benefits, they need to record an expense for the amount they’re paying out of pocket. Some payroll providers offer a PEO (Professional Employer Organization) solution, which aggregates a bunch of employees working for different companies under their umbrella. This allows the PEO to get more competitive rates on health insurance through their various providers.

Current Liabilities

12 - 13 Ah, the joys of living in New York! SDI (state disability insurance) and FLI (family leave insurance, also called Paid Family Leave or PFL) are required for employers with employees in the state of New York. The employees bear the cost through payroll withholdings, which are used to offset the cost of the insurance policies (which employers typically get through an external insurance carrier). The withholding shows up as a liability on the company’s books since payroll softwares don’t remit this amount on the employee’s behalf. The liability is satisfied when payments to the insurance carrier are remitted.

Flow of journal entries for SDI and FLI insurance:

Purchasing insurance

Debit Prepaid Asset xx
Credit Cash xx

Offsetting prepaid asset with withholding

Debit Accrued Payroll Taxes Payable xx
Credit Prepaid Asset xx

Note: no expense is incurred on the company’s books since the policy is funded with employee withholdings.
14 - 16 These line items are the triplet credits to the health benefit expenses incurred by the company for medical, dental and vision. The employer is partially contributing to the employee insurance plans, so they record an expense and corresponding liability. Payments to health insurance providers are made on a monthly basis, so this accrual is burned down once the cash is paid. This journal entry reflects an employer that is part of a PEO, so the health insurance payments are automatically remitted through the system.
17 - 19 Employees with health insurance plans also take deductions out of their paycheck to cover the cost of their healthcare. These are represented as liabilities (without the corresponding expense since it’s the employees’ cost) that are eventually settled once the cash payment to the carrier is made. Health insurance deductions further lower the net pay that is eventually remitted to employees.

Note: employees can also take deductions for plans the employer is not contributing to. Benefits like accident insurance, critical illness and voluntary life can also be reaped by employees (but they will bear the full cost of the plans).
20 Employees can also participate in 401(k) retirement plans. These comes in two main flavors 🍦:
  • Pre-tax 401(k) contribution - funds from the paycheck are sent into the 401(k) before any tax is levied. Any withdrawals are taxed at ordinary income (penalties may also be assessed if withdrawals are made before 59 ½ years of age).
  • Roth 401(k) contribution - taxes will be paid on any funds in the year of contribution. However, these funds can be withdrawn tax free if it’s a qualified withdrawal.
Employers can choose to contribute to their employee plans (if so, they would incur additional benefits expenses). In our example, the company is not contributing so the employee deduction appears as a liability that will be settled once cash is paid to the 401(k) provider. The employer does not incur a corresponding expense.

And there you have the complete dissection of a typical payroll journal entry! To tie the entry back to the supporting docs (i.e. cash requirements report, journal report and pay stubs), see here for a template that breaks down the mapping. Some practical tips I often return to are:

  • Separate out the deductions (aka benefits) versus the payroll taxes (i.e. FICA, FUTA, SUTA, etc)
  • Always be thinking “Who is paying for this benefit or tax? The employer or employee?”
  • Make sure you know what the payroll software is remitting and what you (the employer) are on the hook for
    • A prime example is SDI and FLI insurance - the onus is on the employer to comply
  • Employee net pay = gross pay - all employee taxes withheld - employee benefits deductions
  • Withholdings are not expenses to the employer; rather, they are a reduction of the employee’s take home pay

This is merely the tip of the iceberg with payroll accounting and tax considerations. 🧊 Until next time!

Mackenzie Patel

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