Payroll is integral to any business, large or small, but it can be tricky to navigate without training. It’s tempting to do things on your own, especially when starting out, but payroll mistakes can do more to your business than just a slap on the wrist by the IRS. Unless you avoid the following payroll errors, you could be charged a fine, see jail time, or cause your company to go bankrupt.
How to Avoid These 9 Most Common Payroll Errors
1. Hire a Payroll Service Provider Instead of Trying to Do Everything Manually
Small businesses need a lot of help getting started, but they often don’t seek it because of the high overhead cost. However, you can use a payroll buyer's checklist found online to ensure you have everything you need. Alternatively, you could hire a payroll service provider who will enter into a co-employment relationship with you. They’ll handle your entire payroll process and HR department while taking over the financial and legal liability of your business.
2. Ensure You’re Classifying Workers Properly Before Hiring
Most small businesses will hire two classifications of staff: W-2 employees or 1099 independent contractors. Employees cost more, as employers are responsible for paying them the state-mandated minimum wage (including overtime), benefits, retirement. Employees don’t pay the full extent of their income tax, as the employer takes on a large percentage of this.
Independent contractors are not entitled to overtime pay, benefits, or tax right-offs by the employer. They typically work for themselves, and thus the employer can pay them a wage based on what the contractor states their labor is worth.
There are many other employee classifications, such as temps, interns, volunteers, workers-in-training, remote workers, and foreign workers. It’s your responsibility to classify each worker correctly, as the Fair Labor Standards Act and The Department of Labor have different tax and legal standards for each. Misclassification could result in penalties plus interest.
3. Calculate Overtime Appropriately
Non-exempt employees, which account for most W-2 employees, must be paid overtime pay (1.5x current rate) if they exceed 40 hours a week. Some states have additional requirements. For example, Nevada, Alaska, and California must pay overtime to workers if they exceed the 8-hour workday even if their total weekly timecard doesn’t go above 40 hours that week.
4. Be Diligent with Tax Rates
Tax rates are also commonly miscalculated because they vary based on state and change regularly. You need to calculate the local, state, and federal rates, as well as taxes on overtime pay. Failure to do so will afford you interest, penalties, back pay, and a potential lawsuit.
5. Always Pay Your Workers in the Correct Amount
In 2019, the US Department of Labor collected $322 million in wages owed to workers. Workers are commonly underpaid, whether intentionally or unintentionally, and it can result in your business losing its reputation or a massive amount of money in fees and back pay.
Overpayment is another issue, as it’s difficult to receive money back from your employees. Employees who are aware they’re being slighted will lose their trust in you and may sue.
6. Run Payroll On-Time on a Frequent Pay Period
Employers are responsible for paying within the minimum pay period, which is stated in a contract once hired. Most states have a minimum frequency of weekly, bi-weekly, or monthly, but California separates the frequency based on occupation. Running payroll late won’t just cause financial distress for your workers, but you will receive fines and penalties, a fast-employee term-over rate, and lawsuits. Automate payments to combat this issue.
7. Know the Difference Between Gross vs. Net Pay
Gross pay refers to the wages earned by all employees before taxes, while net pay is the total pay after deductions. Don’t mix these up, or you’ll file your taxes incorrectly. To determine the total payroll cost for your company, you need to also factor in payroll taxes and benefits. As a rule, keep gross payroll and net payroll separate from each other to avoid confusion.
8. Plan Vacations/Leave Accordingly and Pay Your Workers for Time-Off
It’s essential to plan for holiday weeks before an employee leaves, or you could be in a tough position, especially if your HR or payroll staff won’t be in-house. You’ll need to swap staff around, hire temporary employees, or ask the staff going on holiday to prep work in advance.
A small business could lose time and money from wasted productivity, but what’s more concerning is the possibility of late payments or not paying your staff for leave. Workers with one year of experience average 11 days of paid vacation, while those with 5 or more average 15-30 days. While you’re not required to pay for time-off, it can aid in employee retention.
What you are required to pay for worker's compensation. Workers comp pays part of an employee’s regular wage while they recover from illness or injury. Employers are required under the FLSA to compensate employees for time spent waiting for and receiving medical attention.
9. Maintain Payroll Records for at Least Three Years
The IRS can come knocking at your door at any moment, even when you think you’re safe! While that sounds scary, it won’t be if you keep extensive records on file. Failure to show documents when asked could lead to audits and fines. The IRS requires all employers to keep records for all employees, but they need extensive documentation for all non-exempt workers. To comply with IRS standards, you need to keep these documents for at least three years.
