Bookkeeping – Employee Benefits (Lesson 35)
One of the best parts of being a bookkeeper is seeing employees smile when they utilize employee benefits. There are a multitude of different employee benefits out there including:
- Health Insurance
- Retirement
- Life Insurance
- Dental Care
- Vision Care
- Cancer Insurance
- Disability Insurance
- Child Care
- Transportation
In small business the first three are the most commonly purchased. The others are sometimes offered but most employees don’t elect to use them due to cost. When offered, mostly owners and upper management purchase the more elaborate benefits.
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The final benefit is unusual. Instead of a deduction from wages, transportation is actually an additional form of income to the employee and is accounted for in a whole different way. This subject is covered in-depth in another article in this section of the website.
Management decides what benefits to offer. When benefits are available, they are explained to the employee and the employee may sign up for them. Often signing up means authorizing a deduction from their earnings for payment on the plan. A copy of this authorization form is forwarded to the bookkeeper for record purposes. Your job is to place the copy in both the employee’s paper and electronic file. Then set the payroll program up to deduct the appropriate amount from the employee’s check.
The sections below explain the first three benefits in more detail including how the relationship works between the employer, the employee and the benefit provider. In addition there are some tax considerations as to income and FICA (Social Security and Medicare) taxes. In most cases the taxability is affected by the employee’s contribution. Finally each benefit has some compliance requirements and some accounting procedures. I’ll explain them to you and how to account for the benefits.
Let’s get started with the most expensive benefit of all, health insurance.
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Employee Benefits – Health Insurance (General Understanding)
By far health insurance is the most expensive benefit provided by employers. Many small business owners elect against providing health insurance strictly due to cost. On average it costs around $140 per month per employee for plans that only service the individual. Family plans cost $500 or more per month per employee electing that option.
Beginning in January 2016, the current law requires employers with 50 or more full-time employees to provide health insurance or pay a $2,000 per employee penalty.
The typical arrangement is for a provider to allow choices for the employee and the business simply provides a supplemental payment of the premium. In the early 2000’s most employers agreed to provide a flat dollar amount towards any employee’s plan. The idea is to allow the employee the opportunity to elect in or out and if in; pay their share. Most of the small businesses I reviewed would simply pay the first X amount of dollars per month per employee. This forces the employee to pay the balance when they participate.
The plans are generally group based and calculated on performance. On average the premiums increase each year between 9% and 18%.
Under the new law compliance is different. Based on the number of employees and status (full-time or part-time) determines if the employer is forced to offer a plan. For really small businesses the option to elect to provide is still available. The law uses different financial compliance guidance based on the number of employees. Please consult with the company’s CPA for further clarification.
Tax Compliance
In general when an employer pays for any type of benefit it is a deduction for the employer for tax purposes. As for the employee, it is not income to them. The question at hand is the tax aspect of the employee’s payment.
There are two types of taxation when it comes to the employee. The first is fully exempt meaning the employee’s payment is exempt from any type of tax. In this case federal income tax and FICA (Social Security and Medicare taxation). There is a distinct value associated with full exemption as the employee saves money on both income and FICA components. Here is an example:
Regular Deduction Fully Exempt
Gross Wages/Week $600.00 $600.00
Employee’s Share of Health Ins. -0- (100.00)
Adjusted Gross Wages 600.00 500.00
Income Tax Withholding (15%) (90.00) (75.00)
SS/Medicare (7.65%) (45.90) (38.25)
Net Wages 464.10 386.75
Employee’s Share of Health Ins. (100.00) -0-
Net Take Home Pay $364.10 $386.75
Difference 22.65
The actual out-of-pocket costs for the employee is significantly reduced using the fully exempt aspect of taxation. It results in a much better net take home paycheck.
The second form of taxation is an income tax-free benefit. Using the same scenario as above, the outcome looks like this:
Regular Deduction Fully Exempt
Gross Wages/Week $600.00 $600.00
Income Tax Withholding (90.00) (75.00) *On $500.00
SS/Medicare (45.90) (45.90)
Net Wages 464.10 479.10
Health Insurance Deduction (100.00) (100.00)
Net Take Home Pay $364.10 $379.10
Savings $15.00
The net savings is equal to the cost of insurance times the income tax rate; in this case $100 X 15% or $15.00. There is greater overall tax savings under the fully exempt tax rules than income tax-free.
The Internal Revenue Service provides regulations, publications, rulings and other sources of information to comply with either fully exempt or income tax-free deductions. Your job as the bookkeeper is to get guidance from the company’s CPA so that you record the deduction the correct way.
Proper Accounting Techniques
In Lesson 17 parent-child accounts were explained and how they are used to provide additional detail. I encourage small businesses to set up labor in cost of sales as a parent-child account. Sub-accounts include hourly, salary, payroll taxes and benefits. You may consider setting benefits as a parent-child account but with some accounting software such as QuickBooks; this is not a good idea. QuickBooks only allows for one level of expansion (from summation to detail) and not a full expanded mode. An alternative is to use the benefits account as a control account. I believe the 2016 version of QuickBooks will allow for three levels of reporting (the software uses the term ‘Collapse’). Anyway, your account structure in the chart of accounts will resemble this:
Type Account Name Parent Child
Cost of Sales Labor X
Cost of Sales Hourly X
Cost of Sales Salary X
Cost of Sales Payroll Taxes X
Cost of Sales Benefits X
In the cost of goods sold section of your income statement the structure will present in this format:
Cost of Goods Sold
Materials $Z,ZZZ
Labor
– Hourly $Z,ZZZ
– Salary Z,ZZZ
– Payroll Taxes ZZZ
– Benefits Z,ZZZ
Sub-Total Labor ZZ,ZZZ
Equipment Z,ZZZ
Other ZZZ
Total Cost of Goods Sold $ZZ,ZZZ
Now for how to enter data.
First off remember that the insurance provider sends a bill to the company. Each employee is listed along with their respective plan option and cost. I suggest entering the costs per employee using a complex entry under an item code like HI for health insurance (if using the control account method). In the description field identify the employee. For the front and back office personnel (owners, professionals and clerical staff) their benefits are assigned to the benefits account under management in the expenses section of the profit and loss statement.
During payroll processing the employee’s share of the cost is a credit in this benefit account. The following is an example of an employee’s entry, I am skipping breaking out taxes to simplify the entry.
DR CR
Labor – Gross Wages Earned $600.00
Employer Payroll Taxes 45.90
Benefits * Note A $100.00
Payroll Liabilities 166.80
Net Check 379.10
Totals $645.90 $645.90
Note A – Deduction for Health Insurance for the employee’s share, his payment contribution to the employer
A couple of notes to this:
- Health insurance providers are generally prepaid before the next month of services. In effect you’ll get a bill in late January requiring the employer to pay in February for March’s insurance. Employee deductions in February are for March protection. Make sure employees understand this accounting procedure. In addition when an employee terminates you will need to track this particular expense. A lapse in service due to poor accounting is grounds for a civil claim. Monitor this individualized accounting closely.
- If exempt of income tax free method is used then at year end total gross wages on the W-3 will not match wages reported for all labor wage lines. This is because not all the wages are taxable for income, Social Security and Medicare as illustrated in the fully exempt and income tax free column.
In general health insurance is the most complicated of all the benefits offered to employees. It makes sense, the plans are different; costs are different and payroll cycles are different too. Remember this benefit is the most expensive one out there.
Employee Benefits – Retirement
There are about five commonly used small business retirement plans. The most heard of is the 401(k) plan. Right off the bat, I will tell you that if the business doesn’t have at least 100 (one hundred) employees then don’t even consider this plan. It is simply too expensive and restrictive in nature. The other small business plans include:
*Keogh *SEP
*SARSEP *SIMPLE 408(p)
The latter three are covered under Section 408 of the Internal Revenue Code. I endorse and advocate the SIMPLE Plan Section 408(p) of the Code. It is straight forward to implement and utilize. It is also very easy for employees to understand.
Small business retirement plans allow for the employer to contribute a flat percentage of gross wages up to 3% and allows an employee to contribute upwards of 10%. The employer’s contribution is tax deductible for the employer and is recorded to the benefits account. The employee’s contribution is not taxed for income tax purposes. Note I didn’t say fully exempt. The employee’s contribution is still taxed for FICA as a function of gross wages.
Employee Benefits – Life Insurance
This is one of the least expensive benefits to provide employees. Congress authorized the exclusion from income for any premiums paid on a life insurance policy for employees for policies providing benefits up to $50,000 upon death of an employee. The benefits can not accrue to the employer but must go to the beneficiary of choice as designated by the employee.
In general this benefit costs between $12 and $20 per month per employee. It too is recorded as a benefit expense. It is by far one of the best bargains for employers when it comes to providing benefits. No premium value is included in gross or taxable wages of the employee.
Summary – Employee Benefits
There are three common benefits provided by small businesses. They are health insurance, retirement and life insurance. Health insurance requires attention to compliance and the appropriate tax aspect of the employee’s share. Retirement contributions made by employees are deductible for income tax purposes only. Life insurance premiums for policies with face values up to $50,000 are not included in gross wages for employees.
Bookkeepers should allocate the costs between the benefits account of costs of sales under labor and benefits under the management account over in the expenses section of the profit and loss statement. Act on Knowledge.
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