Managing Payroll Liabilities: Tracking and Recording Payroll Obligations

Joyce Zhao
May 8, 2024
min read

Deciphering Payroll Liabilities

In the realm of accounting, various terminologies come into play, each with its own significance. Understanding these terms is crucial for effective accounting practices, and one such term is Payroll Liabilities.

While the term might appear daunting, breaking it down into its components can make it more accessible.

What is Payroll?

Payroll refers to the list of a company's employees and the corresponding amounts they are expected to receive. It also encompasses other pertinent employee-related information essential for making business decisions.

What is a Liability?

Liabilities represent an entity's current obligations that typically arise from past transactions. Put simply, a liability is what an organization owes to external parties.

So, What Exactly is a Payroll Liability?

A payroll liability can be defined as any payment related to employees that an organization owes but has not yet paid.

This means that any amounts owed to employees for work performed are recorded separately from other creditors (accounts payable).

A payroll liability can include wages earned by an employee but not yet received, as well as any amounts deducted from an employee's pay and payable to a third party.

Examples of payroll liabilities include government taxes, insurance premiums, pension contributions, and other payroll-related costs.

These liabilities are typically present in every payroll, as most businesses operate on an accrual basis of accounting, meaning these liabilities are short-term.

Payroll liabilities often include both mandatory and voluntary deductions authorized by the employee.

Mandatory deductions are those amounts required by law to be withdrawn from the employee’s salary by the organization, such as taxes, employee insurance, and pension contributions.

Voluntary deductions are those authorized by the employee, such as child support payments, loan repayments, and union dues.

Significance of Payroll Liabilities

It is crucial for every employer to understand the liabilities they are responsible for to ensure effective planning.

Having a thorough understanding of payroll liabilities is particularly important because employees are the backbone of any organization.

An organization that neglects the needs of its employees is unlikely to thrive in the long term.

Examples of Payroll Liabilities


This category includes regular wages, salaries, overtime pay, retroactive pay, back pay, severance pay, awards, and bonuses. It also includes commissions, prizes, accumulated sick leave pay, and other forms of employee compensation. However, the primary form of compensation is typically wages and salaries. The primary purpose of payroll is to pay your employees, so it's natural for wages to be a significant part of your liabilities. Wages and salaries are usually for a specified period during which the employee works. Before the wage is paid, these wages form part of the payroll liabilities.

Payroll Tax

The most common payroll liability is taxes. When you pay your employees, you are required by law to pay taxes in two forms.

  • The first is the withholding payroll tax, which is taken from the salary of your employee and paid to the government on their behalf.
  • This is considered a liability because you collect this tax from your employee and are responsible for paying it to the government. The second is the payroll tax expense, which is the tax you must pay from your own funds to the government.
  • This is still a payroll tax because the amount is based on the gross wages of your employees.

Cost of Payroll Service

This refers to the expenses involved in creating and managing your payroll system. It includes subscription fees for software programs and fees paid to third parties who manage your payroll system on your behalf.

Pension, Insurance, and Other Deductions

These are deductions made from employees' wages for pension contributions, insurance premiums, and other purposes.

Payroll Expense Versus Payroll Liabilities

While both are essential components of a payroll system, they are distinct and should be treated separately. Payroll expenses refer to any costs incurred in managing the payroll system. On the other hand, payroll liabilities are expenses that have not been paid during the period they are due. They are amounts owed to employees or third parties. Payroll liabilities are typically a subset of payroll expenses.

It's crucial to note that expenses and liabilities in the payroll journal entry offset each other. This means that the expenses and liabilities cancel each other out. The expense account reflects the total amount you are required to pay, representing the total cost incurred in the accounting period. Each liability account indicates either the amount you must deduct from your employee’s salary or the amount you owe to a third party to whom you must remit such funds.

What's the Optimal Solution for Small Businesses to Manage Payroll Liabilities?

Due to the complexity of payroll liabilities, numerous small business owners have faced financial challenges in managing payroll. Avoiding this requires financial planning, which is best achieved with the assistance of a professional accountant.