Payroll errors can cost you fines and even legal penalties. Prevent these problems by learning how to avoid payroll mistakes. Here are 7 of the most common, along with some simple solutions for avoiding them.
1. Failing to Make Payments on Time
Consumers are used to paying taxes once a year. But businesses must pay taxes more frequently, including payroll taxes.
IRS regulations require businesses to make the following deposits on either a monthly or semi-weekly schedule:
- Withheld federal income tax
- Both employer and employee Social Security and Medicare taxes
You must consult IRS publications prior to the beginning of each calendar year to determine whether you are required to make deposits on a monthly or semi-weekly schedule.
The Federal Unemployment Tax Act further requires any unemployment taxes in excess of $500 to be deposited quarterly ( due the end of the month following the quarter).
You must remit federal tax deposits electronically. Pay late and you’ll face penalties, with fines reaching as high as 15%.
In addition to federal obligations, you may be required to make state payroll tax payments for income taxes and unemployment taxes. Regulations vary by state.
For federal payroll tax payment schedule requirements, consult the IRS Employer’s Tax Guide, Publication 15 (Circular E). For state requirements, consult your state’s department of revenue. Because IRS and state instructions can be complicated, many companies find it best to hire a tax professional to assist with setting up payroll payments.
The easiest way to make sure your payments are on time is to schedule automated electronic payments. You can schedule automated payments through the Treasury Department’s Electronic Federal Tax Payment System website. Your state department of revenue may also offer automated electronic payment options.
2. Entering Employee Data Incorrectly
The IRS keys payroll tax records to employee Social Security Numbers, so entering incorrect SSN data can cause headaches. You may waste valuable hours correcting data entry errors, paying extra labor and fines in the process.
The Social Security Administration provides a Social Security Number Verification Service you can use to confirm worker information. The service offers options both for verifying your entire payroll database or for verifying up to 10 names at a time. This tool is useful for processing new hires. Making this a part of your onboarding process will save you time and money.
3. Classifying Workers Improperly
For payroll purposes, workers fall into two categories:
- Employees, who must be paid minimum wage, may be eligible for overtime and must have taxes withheld from their wages
- Independent contractors, who are not entitled to minimum wages or overtime and do not have taxes withheld
Some employers deliberately misclassify employees as contractors to avoid paying overtime or benefits. Because of this, the Department of Labor and the IRS are particularly vigilant about penalizing employers who take this action. Misclassifying a worker can result in fees, penalties, back taxes and legal action.
If you’re not sure whether a worker should be classified as an employee or independent contractor, the Department of Labor provides a test you can use to make this determination:
- How integral is the worker to your company? For example, do they do the primary type of work you perform for your customers?
- How permanent is the worker’s relationship with your company? How long have they worked for you?
- Is the worker invested in your company’s facilities or equipment? Do they use their own equipment?
- How much control does your company have over the worker? For instance, do you set their hours, or do they work on their own schedule? Do they work for any other companies besides yours?
- How much opportunity does the worker have for profit or loss? Can they earn more by doing their job more efficiently or exercising managerial skill? Are they invested in insurance or bonding?
- How much skill and initiative does the worker require to do their job? Do they perform routine tasks that require little training? Does the worker solicit their own business through a website or advertising?
if you’re still not sure how to classify a worker after considering these questions, you can ask the IRS to make the determination for you by filling out Form SS-8.
4. Miscalculating Overtime
If a worker is classified as an employee and they earn less than $455 a week ($23,600 a year), they are normally eligible for overtime under the Fair Labor Standards Act (FLSA) when they work over 40 hours a week. However, certain employees are exempt, such as salaried workers. Additionally, specific jobs are excluded from the FLSA, such as certain agricultural workers and movie theater employees.
In addition to FLSA regulations, state regulations may determine an employee’s exempt status.
Some employers deliberately miscalculate overtime to avoid paying it, so tax authorities penalize overtime misclassifications and payroll mistakes such as deliberate underpayment. Failing to calculate overtime correctly can cost you in back wages, back interest and penalties.
In most circumstances, you can determine whether an employee is exempt from overtime by applying three simple tests:
- Salary level test: Do they earn less than $455 a week ($23,600 a year)?
- Salary basis test: Are they guaranteed a particular pay level regardless of the number of hours they work per week?
- Duties test: Do their job duties involve high-level executive, professional or administrative tasks, such as supervising two or more employees?
The duties test can sometimes be challenging to apply, so the Department of Labor provides fact sheets with more details to help you determine whether an employee is exempt. Check your state overtime laws with your state’s department of labor as well.
5. Failing to File Required Paperwork
The Fair Labor Standards Act requires employers to maintain accurate payroll records identifying information about non-exempt workers, how many hours they worked and how much they earned. Records that must be kept include:
- Employee name and Social Security Number
- Employee birth date
- Employee sex and occupation
- Employee address
- Basis of employee’s wage payments (for example, “$15 per hour)
- Regular hourly pay rate
- Time and day when employee’s workweek begins
- Hours worked each day
- Total hours worked each week
- Total daily or weekly straight-time earnings
- Overtime earnings
- Wage additions and deductions
- Total wages for each pay period
- Date of each payment and pay period covered
Employers may preserve these records in any form they choose, as long as the information is maintained.
Payroll records must be preserved for three years under the FLSA. And records used as a basis for calculating wages, such as work schedules and time cards, must be preserved two years.
State regulations may impose additional record-keeping requirements.
Use a standard form for documenting required payroll information, and make it part of your standard operating procedure to fill out and file your payroll form. The easiest way to do this is to adopt a payroll software app that automatically captures the required data.
Use sound file backup procedures to make sure you retain the necessary documents for the required length of time. Automating your computer backup procedures with a cloud backup service can assist with this task.
Make sure your records filing procedure complies with both federal and state law. Outsourcing to a payroll service provider can help ensure that your records comply.
6. Using Incorrect Tax Table Data
Payroll tax rates continuously change, which can result in you using outdated tax tables if you don’t keep up. Tax rates subject to change include:
- Federal income tax
- Social Security tax
- Medicare tax
- Federal unemployment tax
- State income and unemployment tax
- Local income tax
Failing to keep up with changes in these areas can cost you in extra labor to correct errors and in fees and penalties for payroll mistakes, such as overpayment.
The best way to stay current with the latest tax tables is to make sure your payroll software does automatic updates to reflect recent changes. A payroll outsourcing service can also help you keep up with tax changes. If you choose to manage updates manually, make sure to check the latest rates at least once a year.
7. Failing to Send out W-2 and 1099-MISC Forms
Federal regulations require employers to send employees and independent contractors annual forms summarizing what wages they received and what taxes were withheld from them. Two primary forms are used:
- W-2 forms are sent to employees
- 1099-MISC forms are sent to independent contractors
These forms must be sent to workers by the end of January. Copies must be sent to the IRS by the end of February. Penalties apply for both late and incorrect forms as well as illegible forms.
Make sure your tax filing standard operating procedure includes sending out W-2 and 1099-MISC forms on time. Working with a tax professional will help ensure that this task gets done before the deadline.
It Pays to Know How to Fix Payroll Mistakes
Payroll mistakes are an unnecessary expense that can needlessly cut into your profits. Knowing how to avoid payroll mistakes to retain more of your earnings should form part of your company’s financial strategy.