There are a variety of taxes that a company is required to withhold from an employee's pay, as part of the payroll accounting process. These tax withholdings include the following:
- Federal income taxes
- State income taxes
- Employee portion of Medicare tax
- Employee portion of social security tax
There are also other withholdings that are not taxes, such child support garnishments. In all of these cases, the company is withholding the taxes (or other items) from employee pay on behalf of the taxing entity. This means that the company is liable for paying these withholdings to the government; these payments are not an expense, because the company is merely acting as an agent, transferring cash from employees to the government. The government has required businesses to take on this agency role, for it is easier for the government to monitor remittances through a smaller number of businesses than through a much larger number of individuals.
There are matching portions of payroll withholding taxes that are both an expense of the company and a liability. Both the social security tax and the Medicare tax require matching by the company. Thus, to the extent of the matched amount, a company must debit a payroll tax expense account and credit a liability account. In all cases, a company eliminates its liability by paying the funds to the government.
In situations where a company fails to collect funds from employees that are supposed to be remitted to the government, the company still has an obligation to remit the funds to the government; in this case, the company has incurred both an expense and a liability, though it can later reduce the amount of the expense by obtaining reimbursement from its employees. Reimbursement could be a problem if the employees have since left the company.