What are payroll liabilities? 3 types and employer guide

Payroll processing is complex, meaning you’re likely to struggle to stay on top of the process. According to the 2023 Intuit QuickBooks Small Business Index, U.S. small businesses that use eight or more digital tools, including payroll software, are almost twice as likely to report revenue growth compared to those using just a couple of tools.

A very important part of managing payroll is tracking and paying payroll liabilities. You incur these when you process payroll—and will pay them at a later date. Managing payroll is one of the top challenges for small business owners, according to a Justworks and The Harris Poll survey. 

When you have unpaid wages or payroll withholdings, you have payroll liabilities. They must be properly accounted for and reconciled. Let’s look at the types of payroll liabilities and how they work.

How do payroll liabilities work?

Types of payroll liabilities

Example of how payroll liabilities work

How to pay your payroll liabilities

How to manage payroll accounting

Next steps for streamlining your payroll process

How do payroll liabilities work? 

Payroll accounting includes payroll liabilities as well as payroll expenses. Every business has to record both using the accrual method of accounting. A liability is an obligation to pay an amount. 

Payroll liabilities occur throughout the payroll process, even before you pay employees. For example, you’ll have payroll liabilities for wages you owe to employees and taxes withheld from their checks when you do pay them.

Types of payroll liabilities

Employee compensation, taxes, and payroll deductions all generate liabilities. Here are the key types of payroll liabilities most businesses encounter:

Employee compensation 

Gross wages due to employees are payroll liabilities. There are several workers you need to calculate compensation liability for during a pay period, including: 

• Salaried workers: The portion of annual salary owed for the pay period, plus bonuses and incentive compensation.
• Hourly workers: The total hours worked multiplied by the hourly pay rate, including overtime hours. 

Note that no taxes are withheld on compensation paid to independent contractors. However, you’re required to withhold taxes on employee pay.

Paid time off (PTO)

Paid time off (PTO) is another payroll liability. PTO is the amount of time an employer owes their employees. It’s a liability even if an employee hasn’t taken any time off during the pay period. It’s a liability because employers are responsible for paying out PTO when an employee leaves the company or resigns. In other words, it’s still owed to an employee.

Payroll taxes and insurance 

Taxes are withheld from pay to fund income, Social Security, and Medicare tax liabilities. Common payroll tax and insurance withholdings that create liabilities for employers include: 

• Federal income tax withholdings: The amounts withheld are determined by the worker’s annual income and filing status. 
• FICA taxes: The taxes collected to fund Social Security and Medicare taxes.
• State income taxes: Each state has different requirements for withholding and paying state income tax, and some states don’t impose a state income tax.
• Federal Unemployment Tax Act (FUTA) and State Unemployment Tax Act (SUTA): Both provide temporary income for workers who lose employment. 
• Workers’ comp insurance: If a worker is injured, the insurance policy pays for medical costs and lost wages due to injury.
• Wage garnishments: A garnishment is a court-ordered requirement to withhold employee pay and forward the amounts to a third party.

As your business grows, you may offer benefit plans to motivate employees. Workers can choose to voluntarily withhold payroll dollars to fund benefit plans.  

Voluntary deductions 

Voluntary payroll deductions for benefit programs are funded through payroll withholding. The employer’s share of the costs is a payroll expense. Common voluntary deductions include: 

• Retirement plans: The worker’s contributions are deducted from pay and are not an employer expense. The employer’s share of contributions, however, is a payroll expense.
• Health, dental, vision, and life insurance premiums: Premiums paid by the employer are not withheld from pay and are included as business expenses. The worker’s share of premiums is deducted from pay and is not a payroll expense.
• Union dues: Dues are deducted from pay and forwarded to the union on the worker’s behalf.

Some payroll liabilities are reclassified into a payroll expense account when payments are sent to a third party. The cost incurred to retain an accountant or a payroll provider company is a business expense.

Example of how payroll liabilities work

Assume that a restaurant owes workers $3,000 in payroll for the last five days of March and that the next payroll date is April 5. 

On March 31: 

• $3,000 in wage expense is posted
• A $3,000 increase in wages payable is posted

When payroll is processed on April 5: 

• Cash is reduced by $3,000
• Wages payable are decreased by $3,000

The expense was posted in March when the restaurant employees worked the hours. Revenue in March is matched with March expenses, including the $3,000 in payroll costs. The accrual method posts payroll liabilities and expenses in the same period.

How to pay your payroll liabilities

Payroll liabilities are generated throughout your payroll process. Your payroll process will look something like the following, which will generate payroll liabilities: 

• Collect employee data on Form W-4 (for employees)
• Calculate gross wages using salary or hourly data
• Compute amounts to be withheld
• Withhold amounts and pay each worker’s net pay
• Record payroll liabilities for amounts that will be a business expense, such as FICA taxes
• Submit amounts to each third party using the proper reporting form
• Reclassify payroll liability balances into payroll expense accounts

Note that some variables may change your payroll calculations from one pay period to the next. There can also be changes in payroll expenses and liabilities. These can include tax law changes or employee changes like benefit withholding updates. 

When it’s time to file your payroll taxes, you’ll want to follow these key steps: 

• Federal income taxes: Use Form 941 to report and submit these tax withholdings.
• FICA: Also use Form 941 for these withholdings. 
• FUTA: Use Form 940 to report and submit these payments. 
• SUTA: Use state-specific tax forms to file these payments. 

The frequency of filing these forms varies depending on your location and the size of your payroll.

Form 941 payroll liabilities are the amounts you withhold from employee paychecks to cover federal income tax, Social Security, and Medicare. You’ll report and submit these taxes each quarter using IRS Form 941—even if no wages were paid in a given quarter, some businesses may still be required to file it. Check with your accountant or the IRS guidelines to confirm your filing obligation.

How to manage payroll accounting

When doing payroll accounting, there are several steps you’ll need to follow. Some of the best ways to manage your payroll liabilities include: 

Remember to adjust payroll liabilities

Businesses will need to post adjustments for several types of payroll transactions. For example, payroll liability accounts, like wages payable, are reduced when payroll withholdings are paid to a third party, 

Use payroll software to generate a payroll-liability balance report each time you process payroll. Review the report, so you can post each adjusted journal entry. Accounting also requires account reconciliations.

Reconcile your payroll liabilities

When you reconcile payroll liabilities, you match data from various sources. The data you’ll use to match your payroll records includes: 

• Employee data like pay rates and hours worked
• Payroll tax filings for income and FICA taxes
• Payroll taxes withheld from pay and submitted as tax deposits
• Bank activity for payments to workers and third parties
• Accounting records and transactions posted

To correctly post payroll liabilities, the amounts generated throughout the payroll process must match.

For example, consider payroll reconciliation for federal income tax for an employee:

• Employee’s gross pay and Form W-4 were used to calculate $150 in federal tax withholding
• The business withholds $150 and reports the amount to the IRS
• $150 must be deposited with the IRS
• $150 must be added to the worker’s federal tax withholding for the year and reported on the employee’s Form W-2
• The accounting records must record the amount withheld and paid to the IRS

You can use software to reconcile the payroll liability data and ensure you’re processing payroll correctly.

Accrued payroll liabilities are payroll-related expenses that you’ve incurred but haven’t paid yet. These can include unpaid wages, payroll taxes, employee benefits, or other payroll deductions. You’ll need to track and reconcile these regularly to ensure your liabilities match what’s owed and get recorded in the right accounting period.

Keep proper documentation

Make sure you comply with document requirements and other laws and regulations, such as the Fair Labor Standards Act (FSLA), which establishes rules for the minimum wage, other pay rates, and overtime laws. FSLA also requires that payroll records be kept on file for at least three years.

If you employ union workers, you must comply with the pay and overtime rates required in the collective bargaining agreement with the union. Union pay records must also be kept on file.

Next steps for streamlining your payroll process

Payroll is one of the most time-consuming accounting tasks—and you need the right tools to work efficiently. Automate the payroll process so you can save time and focus on growing your business. Payroll software like QuickBooks Payroll can help streamline your process and seamlessly track liabilities and expenses. 

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