Withholdings taxes are used in a forecast when a portion of a P&L account value needs to be withheld and placed in a liability account on the Balance Sheet. These types of taxes are likely to be applied to salary and wage accounts.
Some common types of Withholdings Tax include:
Medicare/Medicaid, Social Security (US)
Employee’s NI (UK)
Pension contribution paid on behalf of an employee
Frequently asked questions about Withholdings tax:
Setting up a Withholdings Tax
To set up a Withholdings Tax in your forecast,
Go to your Fathom forecast
Click the ‘Cog/Gear’ icon in the lower left corner to open the ‘Forecast Settings’
At the top of the Forecast Settings menu, select the ‘Tax’ tab
In the ‘Withholdings Tax’ section, click the green ‘+ Add type’ option
In the menu that opens, type in a name for the tax you’re creating
Fill out the following fields:
The Balance Sheet liability account the collected tax will be accumulating in
The general tax rate that will be applied to the chosen P&L accounts. Different, account-specific rates can be set up later on in the tax setup. This is the tax rate that will be applied automatically if an account-specific rate is not set up.
The accounting method you are using to recognize the collected tax (Cash or Accrual)
If selected, then Fathom will pay down the entire amount in the Posting to liability account, according to the payment period and tax year you specify.
💡Pro Tip: For payments that do not fit exactly within the payment period scheme, the ‘Advanced Options’ allow for more flexibility in scheduling when payments are made.
If not selected, then you can pay down the Posting to liability account through one-off or recurring journals.
Allowed: If calculated taxes are negative, then Fathom will assume that you are receiving a refund for those tax amounts. Therefore, at the end of the tax period, a refund will be issued for the negative accumulated tax amount; increasing the cash account the tax is being paid from by the same amount.
Not Allowed: If calculated taxes are negative, a refund will not be issued to the cash account the tax is being paid from. Instead, the negative balance will be carried forward to offset future positive calculated tax values.
7. Select ‘Create a new tax type’
Now activate the tax type on the appropriate P&L accounts.
Once created the tax type has been created, you can select the tax and click the ‘Active on 0 accounts’ option
From the drop down options, choose the accounts the tax should be active on. These are the accounts the tax rate will be applied on top of and fees will be collected for and posted to the liability tax.
You can type in different, account-specific tax rates for each account. The account-specific rate you choose will be applied to that account and the collection of that tax will follow the rules you have set for the overall tax.
💡Pro Tip: The ‘Posting to’ liability account will automatically be paid down by your default cash account. If you want the amount to be paid by a different account, then you can select the option to ‘Edit’ the tax and choose a different ‘Paid from’ account.
How a Withholdings tax impacts your forecast
When you create a Withholdings tax in Fathom, the cash to pay the withholdings tax is withheld from the amount listed on the Profit & Loss. The cash withheld for paying the tax is a liability until the tax is paid. Therefore, the tax liability account, or the posting to account, increases along with the cash amount.
The Tax Liability account will increase month over month as tax is withheld as Cash. Journals can be used to pay down this amount or payments can be automated according to a monthly, quarterly, annually, bi-annually, or bi-monthly basis.
Example: A forecast has $20,000 listed in Salaries & Wages for a month with 10% Withholdings tax applied to that expense account, meaning that $2,000 is withheld as cash to pay the withholdings tax.
In the forecast, $20,000 would be listed in the Salaries & Wages expense account on the Profit & Loss. On the forecast’s Balance Sheet, the Cash amount would decrease by only $18,000. The $2,000 needed to pay the Withholdings tax would remain in the Cash account. The $2,000 remaining in Cash for paying the withholdings tax is offset by the liability account the tax is posting to. Therefore, the tax liability account increases by $2,000.
For a quarterly payment scheme, the tax amount will accrue in the Cash and Tax Liability accounts each month until the end of the quarter. At this point, the entire amount in the Tax Liability account will be paid down by the matching withheld Cash amount.
What if I have employees who have different withholdings tax rates all in the same account?
Fathom allows tax rates to be set at the individual account level. If there are different withholdings tax rates impacting the same account, then we recommend using a working effective rate as the tax rate for that account. You can calculate the ‘Working Effective Rate’ according to the following equation:
Working Effective Rate (WER) formula:
WER = (Average monthly amount withheld / Average monthly amount paid in salaries)
What if my account has employees at different withholdings thresholds?
Fathom does not take in transactional or employee-level data. This means that Fathom does not know the salary for each employee or when that employee has met the withholdings threshold for the year so that taxes no longer need to be withheld from their paycheck or now need to be withheld from their paycheck. If a lot of employees meet the threshold, then the working effective tax rate for the Salaries & Wages account may change significantly.
If the tax rate, payment period, or taxed accounts change, then you can add a New Variation of a tax into your forecast. To do this,
Go to the ‘Forecast Settings’ by clicking the ‘Cog/Gear’ icon in the lower left corner of your forecast
Select ‘Tax’ up at the top of the settings
Go to the changing tax and click the ‘Three dot’ icon next to the ‘Edit’ option
From the drop down menu, choose ‘New variation’
Select the month the tax will change
Set the new rate, change the impacted account, and/or choose a new payment period
These changes will automatically be incorporated into your forecast
💡Pro Tip: To return to the original tax rate at the start of the new tax year, you’ll want to create another new variation that starts when the next tax year begins and uses the original tax rate.
How do I account for withholdings taxes matched or paid for by the company?
Because the taxes paid for or matched by the company are not withheld from employees’ paychecks, they are not withholdings taxes. Instead, these would be set up as tax expense accounts in your forecast.
You can learn more about setting up tax expense accounts in your Fathom forecast, by reading the ‘Tax Expense Accounts’ article.