Not all the taxes that you remit for payroll are actually the payroll tax expense for your business. Some of the payroll taxes you remit are withheld from employee pay.
These are part of your expense for wages—not payroll taxes. The employees are paying the deducted taxes. You are merely withholding them from wages and remitting them to the IRS for the employees. That’s reflected on your quarterly payroll tax returns.
The IRS compares details from quarterly payroll tax returns with the annual income tax return of your business. The amounts for wages stated on both types of returns must match. If they don’t, you are likely to receive a notice from the IRS. Replying to the notice requires time and is costly.
In addition, your quarterly payroll tax returns to the IRS should match employee W-2s that you file annually. Remember that payment of any year-end bonuses is part of employee compensation. Bonuses must be reported on both the W-2s and the fourth quarter payroll tax return to the IRS.
Many bookkeeping records incorrectly show all remitted payroll taxes in the same expense category. Also, total net paychecks after deduction of employee taxes is incorrectly recorded as the total expense for wages.
Correcting errors is a difficult task when several pay periods have passed. This causes your accountant to make a shortcut if your bookkeeping does not show as employee wage expense the exact total on the W-2s.
The accountant’s process is to take the amount shown on your books as expense for wages and add to it the expense amount indicated as payroll taxes. The correct amount for wages is then subtracted, which is known from the W-2s or quarterly payroll tax returns. The remainder must be the payroll taxes.
Results from the accountant’s procedure must be reasonable. But, minor inaccuracies are often ignored. This is a disadvantage to businesses with inaccurate records because discrepancies are simply lost income tax deductions. The entire process causes a delay in completing your business tax return. In addition, the cost for preparation of the return is increased.
A common payroll accounting error is failure to record in the bookkeeping system payroll taxes that have accrued at year-end. Most small businesses record expenses when they are paid. This is the “cash basis” accounting method.
However, payroll taxes are treated differently in a cash basis system. Payroll taxes count as deductible expenses for the year that the wages are paid. This means that payroll taxes are deductible this year for any pay date this year—even if you remit the taxes next January. Consequently, payroll taxes paid in January relating to pay dates in the prior year should not be recorded as next year’s expenses. They are expenses for the prior year.
You can’t simply rely upon your accounting software to eliminate errors with payroll. An important step when you create a new corporation is obtaining help with an accurate set up of your payroll system. You should also have your payroll accounting reviewed occasionally by your accountant.
This will assure that your accounting of wages and payroll taxes matches your payroll tax returns. You then avoid having costly problems or missed tax deductions later.