Chapter 8 — Payroll: The Basics a Bookkeeper Must Know

Chapter 8 — Payroll: The Basics a Bookkeeper Must Know

Payroll is where bookkeeping meets the law. Get income recording wrong and your reports mislead you; get payroll wrong and the government fines you. The rules are unforgiving, the deadlines are rigid, and the penalties for late payroll tax deposits are among the harshest in the tax code.

From gross to net

An employee’s paycheck travels a short road with several toll booths. Gross pay is the starting point: hourly wages times hours, or salary for the period, plus overtime, bonuses, or commissions. Then come the deductions, in two families.

Pre-tax deductions come out before income tax is calculated — the employee’s 401(k) contribution and often health insurance premiums. They reduce taxable wages.

Tax withholdings are amounts the employer must hold back and send to the government: federal income tax withholding (based on the employee’s W-4 and IRS tables), state income tax withholding where applicable, and FICA taxes — the employee’s share of Social Security and Medicare.

Net pay — the take-home — is what’s left. The books must track every piece: gross as wage expense, each withholding as a liability owed to the government, and net as cash paid out.

FICA: Social Security and Medicare

FICA is the federal payroll tax that funds Social Security and Medicare. Both employee and employer pay it, and the bookkeeper records both sides.

Social Security: 6.2% each for employee and employer, but only on wages up to the annual wage base — $184,500 for 2026. Once an employee’s year-to-date wages pass that mark, Social Security withholding stops for the rest of the year, for both sides. Your payroll system must track each employee’s cumulative wages to flip that switch at the right time.

Medicare: 1.45% each for employee and employer, on all wages — no wage base, no cap.

Additional Medicare tax: 0.9% on the employee only (the employer doesn’t match it), on wages over $200,000 for single filers / $250,000 for joint filers. The employer withholds it once an employee’s wages exceed $200,000 regardless of filing status — the employee sorts out the exact liability on their tax return.

Example: an employee earns $60,000 in 2026. Employee FICA: $3,720 Social Security plus $870 Medicare — $4,590 total withheld from their pay. The employer matches with its own $4,590, a business expense. Total FICA on that $60,000 of wages: $9,180.

Federal and state withholding

The critical bookkeeping point: withheld taxes are liabilities, not expenses. When you withhold $800 of federal income tax from paychecks, you debit Wage Expense for the gross wages and credit “Federal Withholding Payable”; when you deposit it, debit the liability and credit Cash.

FUTA and SUTA: unemployment taxes

Unemployment insurance is funded by employer-paid taxes — employees don’t pay these. FUTA (federal): 6.0% on the first $7,000 of each employee’s annual wages. But employers who pay their state unemployment tax on time generally receive a credit of up to 5.4%, making the effective federal rate 0.6% — about $42 per employee per year at most. Lose the credit (by paying state tax late) and the bill jumps.

SUTA (state): rates and wage bases vary by state, and new employers typically pay a standard new-employer rate until they earn an experience rating based on their history of unemployment claims. Both are employer expenses, recorded when the wages are paid.

Payroll liabilities on the books

After each payroll run, your books should show exactly what you owe and to whom: federal income tax withheld to Federal Withholding Payable; employee and employer Social Security and Medicare to FICA Payable; federal unemployment to FUTA Payable; state withholding and unemployment to State Tax Payable accounts; net pay not yet disbursed to Wages Payable. Reconcile these liability accounts regularly — the balance in “Federal Withholding Payable” should match what you actually owe per your deposit schedule. A liability account that grows month after month is a screaming alarm: deposits aren’t being made.

A payroll entry, decoded

An employee earns $2,000 gross for the week. From it, the employer withholds: $240 federal income tax, $124 Social Security (6.2%), $29 Medicare (1.45%), and $80 state income tax. The employer also owes its matching $124 Social Security and $29 Medicare, plus $12 in federal and state unemployment taxes.

The entry: debit Wage Expense $2,000 (the true cost of the labor); debit Payroll Tax Expense $165 (the employer’s matching FICA of $153 plus $12 unemployment); credit Cash $1,527 (the net pay: $2,000 − $240 − $124 − $29 − $80); credit Federal Withholding Payable $240, FICA Payable $306, State Withholding Payable $80, and Unemployment Tax Payable $12. That single entry is payroll bookkeeping in miniature: expenses on the debit side, cash out for the net, and a tidy row of liabilities for everything owed to the government.

The calendar, the paperwork, the penalties

Payroll taxes run on strict deposit schedules — monthly or semiweekly depending on the size of your payroll tax liability — plus quarterly Form 941 filings and annual Forms 940, W-2s, and W-3. Miss a deposit and the penalties escalate: the failure-to-deposit penalty runs from 2% up to 15% depending on how late the deposit is, plus interest.

Practical rules: never borrow from payroll tax money — it belongs to the government, and the IRS can assess responsible individuals personally. Use a payroll service or software unless your payroll is truly trivial — the calculations, wage-base tracking, deposit schedules, and filings earn the fee many times over. Keep a full-year payroll calendar with a reminder a week ahead of every deadline. Reconcile payroll quarterly against Forms 941. For new hires, collect a Form W-4 on day one, complete the Form I-9, file state new-hire reporting, and get written direct deposit authorization — payroll errors cluster around new hires, so keep a checklist and use it every time.

Key takeaways

• Gross pay minus pre-tax deductions, tax withholdings, and post-tax deductions equals net pay; track every piece.
• FICA for 2026: Social Security 6.2% (employee and employer) up to the $184,500 wage base; Medicare 1.45% each with no cap; additional 0.9% Medicare on the employee for wages over $200,000 single / $250,000 joint.
• Withheld income taxes are liabilities held in trust — not business expenses, and never to be “borrowed.”
• FUTA is 6.0% on the first $7,000 per employee, generally an effective 0.6% with the state credit; SUTA varies by state.
• Payroll tax deposits run on strict schedules with escalating penalties (2%–15%) — keep a full-year payroll calendar.
• Reconcile payroll liability accounts regularly and tie them to quarterly filings; use a new-hire checklist every time.