Payroll Accounting Guide: Journal Entries & Compliance

Month-end is unforgiving: payroll must be accurate in your books and compliant with the IRS. This guide explains payroll accounting from fundamentals to execution—journal entries, reconciliations, controls, and decisions—so your Form 941, W-2/W-3, and general ledger (GL) agree without surprises.

What is payroll accounting? (Quick definition)

Payroll accounting is the recording and reconciliation of all employee pay and related taxes, benefits, and deductions in the general ledger.

It covers:

• Wages and salaries
• Payroll withholdings (federal income tax, Social Security, Medicare)
• Employer payroll taxes (FICA, FUTA/SUTA)
• Benefits and deductions
• Journal entries that match gross-to-net to cash and liabilities

Payroll accounting vs payroll processing vs HR

If your payroll is late or wrong, everyone notices—so it’s vital to know who owns what. Payroll accounting records and reconciles the financial impact of payroll runs, taxes, and benefits to the GL and financial statements. Payroll processing calculates gross-to-net, pays employees and agencies, and files payroll tax returns. HR manages people policies, classifications, and compensation plans.

In practice, processing feeds accounting. The processor (in-house or vendor) produces pay registers and tax reports. Accounting maps them to wage expense, employer taxes, payroll liabilities, and cash.

HR defines roles (exempt vs nonexempt under DOL FLSA), pay rates, benefits, and approvals. These decisions drive calculations and compliance risk.

Accountability matters. Misclassification (1099-NEC vs W-2), wrong FLSA overtime rules, or missed deposit schedules can trigger penalties and back pay.

A simple RACI:

• HR defines and approves.
• Payroll processing calculates and disburses.
• Accounting records, reconciles, and reports.

Keep roles distinct, but align on a shared close checklist.

Bottom line: payroll processing pays people correctly and on time. Payroll accounting makes sure every dollar is recorded, reconciled, and compliant. HR ensures the underlying people decisions are legal and documented.

Core components: wages, taxes, benefits, and deductions

Every payroll run turns hours and policies into dollars and liabilities. To post correct payroll journal entries, identify earnings, calculate taxes, split employer vs employee costs, and track benefits and deductions. Clear definitions reduce mapping errors and keep your GL clean.

Most SMBs share the same building blocks:

• Compensation (wages/salaries, overtime, bonuses)
• Withholdings (federal/state income tax, Social Security, Medicare)
• Employer payroll taxes (FICA match, FUTA/SUTA)
• Benefits and deductions (401(k), HSA, health insurance, garnishments)

The rest of this section breaks each down.

Compensation elements: wages, salaries, overtime, bonuses, commissions

Compensation is the starting point for payroll accounting. Wages (hourly) and salaries (fixed) form base pay. Overtime and differentials adjust for hours and schedules under FLSA rules. Bonuses, commissions, and supplemental wages add variability and often different tax treatment.

Example: A nonexempt employee works 50 hours at $20/hour. Overtime (10 hours) is paid at 1.5x, adding $300 to the $1,000 base, for $1,300 gross. If you pay a $1,000 bonus, federal withholding may use flat supplemental rates (see IRS Pub 15). These details drive your payroll journal entries.

Takeaway: track earnings types separately (regular, OT, bonus, commission). It improves analytics (overtime %) and makes GL mappings and reconciliations smoother.

Withholdings and employer taxes: federal, state, FICA, Medicare, FUTA/SUTA

Payroll withholdings are amounts taken from employee gross pay for taxes and deductions. Key taxes include federal income tax (FIT), Social Security (6.2% up to the annual wage base), and Medicare (1.45% plus 0.9% additional Medicare for high earners). States add income tax and SUTA rules, and localities may add city or school taxes.

Employers owe matching Social Security (6.2%) and Medicare (1.45%). They also owe FUTA (federal unemployment) and state unemployment (SUTA) per state rates and wage bases. These employer payroll taxes are business expenses and separate from employee withholdings. Deposit schedules (monthly or semi-weekly) flow from prior liability totals (see IRS Pub 15).

Action tip: set separate liability accounts for each tax type (FIT, SS, Medicare, state, local, SUTA). It simplifies Form 941 reconciliation and identifies late/missed deposits quickly.

Benefits and deductions: pre-tax vs post-tax (401(k), HSA, insurance, garnishments)

Benefits and deductions change both taxable wages and net pay.

• Pre-tax deductions (e.g., 401(k), Section 125 health/dental/vision, HSA) reduce taxable wages for federal income tax and often FICA/Medicare depending on plan type (see IRS Pub 15-B).
• Post-tax deductions (e.g., Roth 401(k), union dues, charitable) do not reduce taxable wages.

Garnishments and court-ordered deductions (child support, levies) have strict priority and limits under federal and state law. In accounting, these are withheld from net pay, posted to a liability account, and remitted to the agency by due date. Missteps can trigger penalties and employer liability.

Takeaway: label benefit codes as pre-tax or post-tax in your payroll system and map each to a distinct GL account. This ensures taxable wages, payroll liabilities, and remittances are correct.

Gross-to-net: how payroll flows into the general ledger

Your goal is simple: every payroll run posts wage expense and employer taxes, offsets employee withholdings to liabilities, and clears cash. The fastest way to control this flow is a payroll clearing account that zeroes each cycle. When it doesn’t, you know something is missing or mis-mapped.

The gross-to-net path is:

• Earnings and employer taxes are expenses.
• Employee withholdings and employer taxes become liabilities.
• Net pay and tax payments reduce cash.
• A temporary clearing account validates completeness.

This structure makes month-end and Form 941 reconciliation straightforward.

Using a payroll clearing account (with mapping example)

A payroll clearing account is a temporary GL account used to collect payroll cash disbursements and ensure the payroll entry balances to cash movement. It should return to zero after you post net pay and tax payments.

Example mapping for each payroll:

1) Record payroll:

• Dr Wages Expense (gross)
• Dr Employer Taxes Expense (ER FICA, FUTA/SUTA)
• Cr Employee Tax Withholdings Payable (FIT, SS, Medicare, state)
• Cr Benefits/Deductions Payable (401(k), insurance, garnishments)
• Cr Payroll Clearing (net pay plus employer tax cash if vendor debits your account)

2) When cash leaves the bank:

• Dr Payroll Clearing
• Cr Cash (net pay and any vendor tax sweep)

3) When you remit taxes/benefits (if paid separately):

• Dr Related Liability
• Cr Cash

If the clearing account doesn’t zero, something didn’t post or was mis-mapped. Use it as your early-warning control.

Common mapping errors and how to spot them

Small mapping mistakes create big reconciliation headaches. Review this list regularly and correct issues before quarter-end.

• Net pay posted directly to Cash, bypassing the clearing account. Fix: route through Payroll Clearing so the account zeroes each run.
• Employee and employer Social Security combined into one account. Fix: separate employee withholdings (liability) from employer tax expense.
• Pre-tax deductions mapped to expense instead of liability. Fix: map withholdings to a liability and recognize employer-paid premiums as expense.
• State/local taxes lumped into FIT. Fix: create distinct liability accounts for each jurisdiction.
• Bonus earnings mapped to overtime expense. Fix: separate earnings codes and GL accounts for clarity and analytics.
• Employer-paid benefits expensed twice (vendor bill and payroll). Fix: choose one source of truth and offset duplicates with a correcting entry.
• Garnishments withheld but not remitted. Fix: reconcile liability aging monthly and set payment reminders.
• Vendor tax sweep recorded as expense, not liability reduction. Fix: debit the liability accounts when the sweep occurs.
• Not using wage bases, causing over-accrual after caps are met. Fix: align payroll system settings with current-year wage bases.
• Accrual reversals missing. Fix: auto-reverse monthly payroll accruals on day one of the next period.

Journal entry examples (step-by-step)

Accurate payroll journal entries prevent painful reconciliations later. Use consistent GL accounts, document assumptions, and attach payroll registers or vendor summaries as support. The examples below use simple numbers to illustrate the flow.

Hourly payroll entry (wages, employee taxes, employer taxes, benefits)

Assume for the pay period: gross wages $50,000; employee FIT $6,000; employee SS $3,100; employee Medicare $725; state tax $2,000; 401(k) employee $2,500; health insurance employee $1,200; employer SS $3,100; employer Medicare $725; FUTA/SUTA $400. Net pay is what remains after withholdings and deductions.

Record payroll:

• Dr Wages Expense 50,000
• Dr Employer Payroll Taxes Expense 4,225 (ER SS 3,100 + ER Med 725 + FUTA/SUTA 400)
• Cr Federal Income Tax Payable 6,000
• Cr Social Security Tax Payable (EE) 3,100
• Cr Medicare Tax Payable (EE) 725
• Cr State Income Tax Payable 2,000
• Cr 401(k) Contributions Payable (EE) 2,500
• Cr Insurance Premiums Payable (EE) 1,200
• Cr Payroll Clearing 38,700 (plug to balance = net pay)

When payroll cash leaves bank (net pay):

• Dr Payroll Clearing 38,700
• Cr Cash 38,700

When the vendor sweeps taxes/benefits (if applicable) or you remit:

• Dr Each Liability (FIT, SS, Med, State, 401(k), Insurance) per amounts
• Cr Cash total remitted

Salaried payroll entry and PTO accrual

Salaried employees simplify hours but not accounting. If a pay period spans months, you’ll need a payroll accrual. PTO liabilities accrue as benefits are earned and reverse as time is taken.

Record a salaried run (example): gross salaries $80,000; withholdings $16,000; net pay $64,000; employer taxes $6,400.

• Dr Salaries Expense 80,000
• Dr Employer Payroll Taxes Expense 6,400
• Cr Payroll Withholdings Payable 16,000
• Cr Payroll Clearing 70,400

PTO accrual at month-end (employee earned 200 hours valued at $30/hour = $6,000 liability):

• Dr PTO Expense 6,000
• Cr PTO Liability 6,000

When PTO is taken, reduce liability:

• Dr PTO Liability (hours taken × rate)
• Cr Cash or Payroll Clearing (if paid via payroll)

Bonus gross-up and supplemental wage entries

When you promise a net bonus, gross-up to cover taxes so the employee receives the exact net. Suppose you want the employee to net $5,000 and apply a 22% federal supplemental rate plus 7.65% FICA/Medicare and 5% state (example, confirm your jurisdiction).

Compute gross-up (simplified): Net = Gross × (1 − total rate). Total rate = 22% + 7.65% + 5% = 34.65%. Gross = 5,000 / (1 − 0.3465) ≈ 7,646.

Entry:

• Dr Bonus Expense 7,646
• Dr Employer Payroll Taxes Expense (ER SS/Med on gross) ≈ 585
• Cr FIT Payable (EE) ≈ 1,682
• Cr SS Payable (EE) ≈ 474
• Cr Medicare Payable (EE) ≈ 111
• Cr State Tax Payable (EE) ≈ 382
• Cr Payroll Clearing ≈ 5,000

Verify using your payroll system; actual rates, wage bases, and additional Medicare may change the figures.

Garnishments and court-ordered deductions

Garnishments require precise withholding and timely remittance. They reduce net pay and create a liability until paid. Example: $300 child support withheld this period.

Record payroll impact:

• Dr Wages/Salaries Expense (gross)
• Dr Employer Payroll Taxes Expense (employer portion)
• Cr Taxes Payable (employee)
• Cr Child Support Payable 300
• Cr Payroll Clearing (net pay)

When remitted:

• Dr Child Support Payable 300
• Cr Cash 300

Best practice: track each garnishment in a sub-ledger to avoid missed payments and penalties.

Month-end and year-end close: accruals, reversals, and reconciliations

At month-end, your 941 and the GL must agree—here’s the fastest way to tie them out. A disciplined close reduces audit risk, speeds year-end W-2s/W-3, and prevents deposit penalties.

Use this month-end payroll close checklist: 1) Post all payroll runs and vendor tax sweeps through the last business day. 2) Record a payroll accrual for earned but unpaid wages and employer taxes. 3) Reconcile payroll liabilities by tax and benefit type; clear old items. 4) Zero the payroll clearing account; investigate any residual balance. 5) Tie Form 941 totals for the quarter to the GL; resolve variances. 6) Review benefit invoices vs payroll deductions; fix duplicates or gaps. 7) Prepare reversals for next month and document support.

Payroll accrual entry and reversal (timing differences)

When a pay period crosses month-end, accrue earned wages and employer taxes. Example: 3 days earned, estimated gross $30,000; employee withholdings $6,000; employer taxes $2,400.

Accrual:

• Dr Wages Expense 30,000
• Dr Employer Payroll Taxes Expense 2,400
• Cr Accrued Payroll Liability 26,400 (net)
• Cr Payroll Taxes Payable 6,000

Reverse on the first day of the next month:

• Dr Accrued Payroll Liability 26,400
• Dr Payroll Taxes Payable 6,000
• Cr Wages Expense 30,000
• Cr Employer Payroll Taxes Expense 2,400

When the actual payroll posts, the reversal offsets the accrual and leaves only true variances to adjust.

Reconcile payroll liabilities: 941 → W-3/W-2 → GL tie-out

Do this each quarter and at year-end. Consistent tie-outs prevent amended returns and scramble fixes in January.

1) Tie Form 941 to W-3/W-2:

• Compare 941 Line 2 (wages) to W-3 Box 1 totals (adjust for pre-tax).
• Match 941 SS/Med wages and taxes to W-2 Boxes 3–6.
• Confirm FIT withheld (941 Line 3) equals W-2 Box 2 totals.

2) Tie 941 to GL:

• Sum quarterly payroll liability credits (FIT, SS EE, Med EE, SS ER, Med ER) and compare to 941 tax totals.
• Compare deposits per EFTPS/payroll provider to GL cash credits and liability debits.

3) Resolve differences:

• Identify timing (end-of-quarter accruals), wage base caps, corrections (941-X), and voids/reissues.
• Post adjusting entries and document.

Keep copies of the 941, W-3 transmittal, W-2 control totals, GL detail, and deposit receipts in your close binder.

Variance troubleshooting: top 10 causes and fixes

Most discrepancies fall into a few patterns. Use this list to triage variances quickly and document resolutions.

• Timing: accrual spans quarter-end. Fix: adjust and document timing differences.
• Wage base caps: SS stops after the cap. Fix: update payroll settings and true-up entries.
• Pre-tax misclassification: benefits treated as post-tax. Fix: correct mappings and amend if material.
• Voided/reissued checks: not reversed in GL. Fix: reverse original and repost corrected run.
• Duplicate employer tax expense: vendor bill plus payroll entry. Fix: choose one source and reverse duplicate.
• Local taxes missing: unpaid jurisdiction. Fix: add liability and remit with penalties as needed.
• Prior-period adjustments posted current quarter. Fix: reclassify or document as reconciling items.
• Garnishments held, not remitted. Fix: clear liability and set payment controls.
• Rounding and supplemental rate differences. Fix: reconcile to provider detail and post small adjustments.
• Provider mapping changes mid-quarter. Fix: re-map and post cumulative correcting entries.

Deposits and filings: schedules, thresholds, and penalties

Late deposits are expensive—penalties start at 2% and escalate. Know your schedules, monitor thresholds, and calendar every due date. IRS Pub 15 explains deposit rules, and each state has its own.

Key federal filings and deposits:

• Form 941: quarterly federal payroll tax return; deposit FIT, SS, and Medicare on monthly or semi-weekly schedules based on lookback. Next-day rules may apply for $100,000 liabilities.
• Form 940: annual FUTA; state credits may reduce liability.
• W-2/W-3: employee statements and SSA transmittal due after year-end.
• State returns: income tax and unemployment filings vary by state; enroll in e-file systems.

If you underpay or pay late:

• Record the additional liability and penalties/interest:
• Dr Penalties and Interest Expense
• Cr Tax Penalties Payable (or Cash when paid)
• Correct returns with 941-X if necessary, and document cause and remediation.

Special scenarios

Edge cases create outsized risk and variance. Address multi-state, tipped and fringe benefits, and equity compensation with clear rules, examples, and entries.

Multi-state payroll and remote work nexus (allocation and liabilities)

Remote work can trigger withholding and unemployment in multiple states. Generally, withhold in the employee’s work state and apply reciprocal agreements when applicable. SUTA is usually tied to a primary work location per state priority tests.

Example: An employee works 60% in NY and 40% in NJ. Set up multi-state allocations in payroll, withhold accordingly, and map each state tax to a separate liability. For SUTA, follow the four-factor test (localization of work, base of operations, direction and control, residence).

Action steps: 1) Register for withholding and SUTA where required; obtain IDs before running payroll. 2) Configure multi-state profiles and GL mappings per state. 3) Reconcile state-by-state liabilities and filings monthly.

Tipped employees and fringe benefits (imputed income)

Tipped employees must report tips; employers must withhold and pay FICA/Medicare on reported tips. Tip credits can reduce cash wage requirements but carry strict documentation under FLSA.

Fringe benefits like personal use of company car or group-term life (> $50,000) create imputed income (see IRS Pub 15-B).

Accounting example for imputed income $200:

• Dr Payroll Tax Expense (ER share of FICA/Medicare)
• Cr FICA/Medicare Payable (ER)
• Dr Wages Expense 200
• Cr Imputed Income Payable 200

Then treat as taxable wages in the next payroll. Withhold applicable taxes and clear the payable.

Keep tip declaration forms and monthly allocations. Reconcile FICA on tips to 941 and W-2 Boxes 7–8.

Equity compensation (RSUs/NSOs) and payroll tax withholding

When RSUs vest or NSOs are exercised, taxable wages arise even without cash paid to the employee. Withhold FIT and FICA/Medicare. Many companies use net share settlement or sell-to-cover to fund taxes.

Example RSU vest $20,000, taxes withheld $7,000:

• Dr Stock Compensation Expense 20,000
• Cr Payroll Tax Withholdings Payable 7,000
• Cr Additional Paid-in Capital (or Equity) 13,000

When taxes are remitted:

• Dr Payroll Tax Withholdings Payable 7,000
• Cr Cash 7,000

Coordinate closely between equity admin, payroll, and accounting to avoid W-2 underreporting.

Internal controls and risk management

Payroll fraud and errors thrive in gaps between HR, payroll, and accounting. Build simple, strong controls—segregation of duties, approval workflows, and audit trails—to protect cash and compliance.

Segregation of duties, approvals, and audit trail

Separate who:

• Creates/edits employees (HR)
• Processes payroll (payroll specialist)
• Approves payroll (manager/controller)
• Posts entries and reconciles (accounting)

Implement:

• Written approvals for pay rate changes and bonuses
• Ghost employee checks (compare payroll roster to HR roster and IT access)
• Positive pay and direct deposit validation
• Quarterly access reviews in payroll and HRIS
• Documented close checklist with sign-offs

These controls reduce error rates and support audits and SOC reviews.

Outsourced providers and PEOs: SOC 1, responsibilities, and pitfalls

Vendors reduce workload but not your accountability. Request and review your provider’s SOC 1 Type 2 report and complementary user entity controls. For PEOs/EORs, co-employment shifts tax filings to the PEO EIN, but you still must reconcile expenses and monitor accuracy.

Common pitfalls:

• Assuming vendor postings equal GAAP. You still need accruals, reversals, and reconciliations.
• Not reviewing tax notices. Set up e-services to receive agency alerts directly.
• Losing visibility with a PEO. Obtain detailed wage/tax registers to tie to your GL and budgets.

Clarify who handles amendments, agency responses, and penalty abatement before you sign.

In-house vs outsourcing vs PEO: decision framework and costs

Choosing the right model balances cost, control, and compliance. Use this quick framework:

• In-house payroll:
• Pros: maximum control, custom GL mapping, fast adjustments.
• Cons: higher admin burden, requires expertise and backups.
• Costs: software + staff time; add risk cost if compliance is weak.
• Outsourced payroll provider:
• Pros: automation, tax filing included, solid integrations, SOC 1 coverage.
• Cons: mapping errors still possible; change requests take time.
• Costs: per-employee-per-month (PEPM) + per-run fees + W-2 fees.
• PEO/EOR:
• Pros: benefits scale, co-employment risk sharing, multi-state ease.
• Cons: less EIN control, complex GL allocations, potential higher PEPM.
• Costs: percent of payroll or PEPM; compare total comp/benefits savings.

Decision criteria: 1) Complexity (multi-state, tipped, equity) 2) Headcount and growth rate 3) Need for GL control and close speed 4) Internal expertise and coverage 5) Compliance tolerance and audit needs

Pilot with a single payroll source-of-truth and a 60-day reconciliation milestone.

Payroll software and GL integration

Strong integrations turn payroll data into clean accounting. Plan your chart of accounts, mapping templates, and import cadence before your first run to avoid rework.

Mapping templates and import files/APIs

Build a mapping template that lists:

• Earnings types → wage expense accounts (regular, OT, bonus)
• Employee taxes → liability accounts (FIT, SS, Medicare, state, local)
• Employer taxes → expense accounts (ER FICA, FUTA/SUTA)
• Benefits/deductions → liabilities and employer-paid expenses
• Net pay → payroll clearing

Integration options:

• Flat files (CSV) posted per pay run with batch IDs
• APIs with automatic journal creation and error reports
• Attach source files (registers, tax summaries) to each journal for audit trail

Reconciliation checklist per run: 1) Clearing account zeros 2) Total wages agree to payroll register 3) Liabilities equal pending remittances 4) Cash movements match bank activity

Common setup mistakes and how to fix them

• Using one generic “Payroll Expense” account. Fix: break out wages, employer taxes, and employer-paid benefits.
• Mapping employee and employer taxes together. Fix: separate for reconciliation and analytics.
• Ignoring departments/locations. Fix: add dimensions to analyze cost per team and state.
• No auto-reversal on accruals. Fix: set auto-reverse in your GL.
• Posting drafts without review. Fix: implement a two-step approval workflow with variance thresholds.
• Skipping sandbox testing. Fix: test one mock run end-to-end before go-live.

Key metrics and continuous improvement

What gets measured gets managed. Track a few KPIs to spot issues early and improve payroll accounting performance.

Payroll cost per employee, overtime %, error rate, close timing

• Payroll cost per employee = (Wages + Employer Taxes + Employer-Paid Benefits) ÷ Avg headcount
• Overtime % = Overtime dollars ÷ Total wage dollars
• Payroll error rate = Corrections/adjustments ÷ Total paychecks
• Close timing = Days to close payroll sub-ledger and reconcile 941 → GL
• Late deposit count and penalties paid
• Payroll liabilities aging (items >30 days)

Use a monthly dashboard and target continuous reductions in errors and close time.

Quick FAQs

• Is payroll an expense or a liability? Both. Wages and employer payroll taxes are expenses; employee withholdings and unpaid amounts are liabilities until paid.
• How do you record payroll in accounting? Debit wages and employer taxes; credit tax and deduction liabilities; credit payroll clearing; then debit clearing and credit cash when paid.
• What is included in payroll accounting? Wages/salaries, overtime, bonuses, employee withholdings, employer payroll taxes, benefits/deductions, accruals, and reconciliations to 941/W-2/W-3.
• 1099-NEC vs W-2 classification? Employees (W-2) are subject to payroll taxes and labor laws; contractors (1099-NEC) are not. Misclassification risks back taxes and penalties (see IRS guidance).
• Net pay vs gross pay? Gross is total earnings; net is take-home after withholdings and deductions.
• Payroll accrual journal entry at month-end? Dr Wages Expense and ER Taxes; Cr Accrued Payroll and Tax Payables; reverse next period.
• How to reconcile Form 941 to the GL? Match wages and taxes to 941 lines; tie deposits to liability reductions; resolve timing and mapping differences.
• How do I fix a payroll tax deposit error or late payment? Record penalties/interest, remit the shortfall, consider filing 941-X if needed, and adjust GL liabilities accordingly.

References and update notes

Authoritative sources:

• IRS Publication 15 (Circular E): Employer’s Tax Guide
• IRS Publication 15-A: Employer’s Supplemental Tax Guide
• IRS Publication 15-B: Employer’s Tax Guide to Fringe Benefits
• Form 941 and 941-X Instructions; Form 940 Instructions
• DOL Wage and Hour Division: Fair Labor Standards Act (FLSA) Overtime Rules
• American Payroll Association (APA) resources and certification frameworks

Update notes:

• Tax rates, wage bases, and deposit thresholds change annually. Confirm current-year Social Security wage base, FUTA credit reductions, supplemental withholding rates, and state rules before posting entries.
• Multi-state and local taxes vary widely; verify each jurisdiction’s registration and filing cadence.
• This guide is educational and not tax advice; consult your CPA or payroll professional for your facts and states.

Updated for the current filing cycle. Verify all rates and forms against the latest IRS and state publications before you run payroll.