If you accidentally underpay an employee, you’ll undoubtedly hear about it. But if you slip and overpay your employees, you may not know for weeks or months. As a business owner, it’s up to you to manage payroll with the same precision you afford to every other part of your business.
Here are some of the most common payroll errors and how to avoid them.
1. Not paying overtime
The Fair Labor Standards Act (FLSA) requires that non-exempt employees earn overtime when they work more than a standard workweek, usually 40 hours. States further specify what constitutes overtime. The standard overtime rate is time and a half.
For example, non-exempt employees in California earn overtime pay on hours worked past eight hours in one workday. So if your hourly employee works a 10-hour shift, you’re required to pay overtime for the final two hours of work, regardless of whether the employee worked more than 40 hours during the workweek.
2. Miscalculating payroll taxes
As an employer, you’re responsible for holding onto a portion of employees’ gross pay for taxes. If you incorrectly calculate gross pay, your payroll taxes will also be off.
Getting payroll taxes wrong can happen for three reasons:
- You miscalculated the taxable wage base.
- You used the wrong tax rate for the calculation.
- You forgot to withhold pay for a specific tax.
For example, let’s say you didn’t pay employees at their overtime rate when you should have. Because you calculated payroll taxes based on the wrong gross wages amount, payroll taxes are also wrong.
You also might not be aware of all the payroll taxes that apply to employee earnings. If your business hasn’t paid an employee more than $200,000 before, you might be unaware that you’re required to withhold 0.9% in additional Medicare taxes after reaching $200,000 in earnings for the year.
You can avoid some payroll tax miscalculations with payroll software, which calculates payroll taxes automatically. Talk to an accountant about correcting payroll tax errors.
3. Not remitting payroll taxes and quarterly filings
Every time you process payroll, your payroll software sends off federal, state, and local payroll taxes to the appropriate authorities. It also files a quarterly Form 941 to reconcile the amount of federal taxes you’ve deposited with the amount you owe to make sure you haven’t overpaid or underpaid.
When you don’t remit payroll taxes or file a Form 941 on time, you face harsh penalties outlined on page 21 of the . It’s always worth double-checking your payroll portal for snafus in filing and remitting payroll taxes.
4. Inappropriately classifying workers
You can run into serious trouble for misclassifying a worker as an independent contractor. Many small business owners unknowingly compensate workers as if they’re contractors despite treating them like employees. When you make this payroll mistake, get in touch with a CPA to remedy it as soon as possible.
In virtually all cases, businesses pay independent contractors without withholding taxes. However, employers must retain a portion of employee compensation for payroll taxes and buck up for employer-paid taxes, including unemployment taxes and one-half of FICA taxes (from the Federal Insurance Contributions Act), which help to fund Social Security and Medicare.
The difference between employees and contractors comes down to three things:
- Behavioral control: Employees work within certain hours, report to an office, and receive training for their work. Independent contractors work on their own schedules and aren’t told exactly how to complete their projects.
- Financial control: Employees receive equipment from their employer and are reimbursed for business-related expenses they incur. Contractors usually use their own equipment and deduct work-related expenses on their tax returns.
- Worker-business relationship: Employees can take advantage of employer-provided perks like retirement and subsidized health plans. Contractors are business owners who provide benefits for themselves.
The line between employees and independent contractors can get blurry, so meet with a CPA to set boundaries in your workplace that distinguish between the two groups of workers.
5. Running payroll late
It’s 6 a.m., and your employee Chris is just waking up so he can get to work on time. It’s payday, and he can’t wait to check his phone for a deposit notification. He opens his email inbox and finds just a few ads but no payday email. Before Chris has wiped the crusties out of his eyes, you’ve already let him down.
Paying late consistently can land you in hot water with your employees and the government. Paying employees late not only lowers morale but also risks FLSA labor law infringement.
Most online payroll solutions will remind you to run payroll a few days before payday so that paychecks reach workers’ bank accounts on time.
6. Failing to keep payroll records
Bookkeeping creates your business’s financial paper trail. In the unlikely event of an IRS audit, you’ll need to back up every reported revenue and deduction with documentation.
Governments set payroll recordkeeping requirements. Check out our guide to payroll records for a breakdown.
7. Not including fringe benefits as taxable compensation
Fringe benefits are the perks that businesses offer as part of employee compensation packages. Subsidized health insurance plans, gym memberships, and commuter benefits are just some of the extras that small businesses extend to employees.
Most fringe benefits are taxable compensation to employees. You’re committing a payroll error when you fail to include taxable fringe benefits in employee gross pay.
However, not all fringe benefits are subject to all payroll taxes. For example, employer health insurance plan contributions are exempt from federal and payroll taxes.
An accounting professional can help you decipher how payroll works and which fringe benefits create payroll liabilities.
Don’t wait for an IRS letter to check for payroll errors
Take preventive steps to identify and rectify payroll errors before employees or tax authorities are asking you questions.
The best way to catch errors is to complete a payroll reconciliation after every payroll run. If you catch a mistake, talk to your accountant to figure out the correct next step.