Tips for Vacation Pay Accounting

Accounting for regular employees’ vacation

Here are the journal entries for accruing and distributing vacation pay:

To accrue vacation pay:
- Accrued Vacation Expense xxx
- Vacation Payable xxx
To distribute vacation pay:
- Vacation Payable xxx
- Cash xxx

Important: Also accrue employment taxes (see Payroll Taxes page).

Vacation pay under §125 (cafeteria) plans

Vacation time purchased with pretax dollars comes under three special rules. [IRS Prop. Reg. §1.125-2, Q&A A-5(c); IRS Temp. Reg. §1.125-2T, Q&A-1]

Rule #1. Purchased vacation time cannot be carried over into another plan year.

Rule #2. Vacation days can be cashed out only before the end of the plan year or before their individual tax year, whichever is earlier. Once the plan year has ended, the employee loses that option.

Rule #3. Purchased vacation days may not be used until all of the employee’s normal earned or accrued vacation time is used.

Example: Lee accrues 10 vacation days under DiCo’s vacation policy and purchases 5 days under DiCo’s calendar-year cafeteria plan. At the end of the plan year, which happens to be Dec. 31, Lee intends to use 13 vacation days. He must cash out the 2 remaining days before the earlier of the plan’s year end or his tax year, or forfeit the 2 unused days.

Vacation days purchased with pretax dollars are income when cashed out, subject to FIT, FICA, FUTA, state and local taxes. An employer can choose its FIT withholding method for the payments, but the amount withheld must be approximately the amount withheld under the percentage withholding method. Small discrepancies between the wage-bracket and percentage withholding methods are allowed if the method does not result in consistent underwithholding.

Content courtesy of www.AIPB.org

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