Mistakes are often thought of as part of life, but when it comes to your business’ payroll, mistakes can come with big consequences. And even what you may consider a small mistake can cost your company a fortune. Due to constantly changing tax rules and regulations, processing payroll is an increasingly tedious task for small and mid-sized business owners.
In fact, between 2001 and 2012, there was an average of one change per day to the tax code! Now that’s a lot to stay on top of, in addition to the other components of running a successful business. To help you avoid payroll pitfalls, we’ve outlined the top payroll mistakes businesses make.
1. Misclassifying Employees as Independent Contractors
In today’s business world, there are many different types of workers including consultants, temps and independent contractors, which can cause confusion when classifying them. With the federal government cracking down on companies that wrongfully classify employees as independent contractors, accuracy is a must. So, how do you know what type of worker you have? In general, if the employer controls what type of work will be done by the worker, when and how, then the worker is an employee and not an independent contractor. But it isn’t always that easy to make the determination. What happens if you do happen to misclassify a worker on your tax return? The company will be liable for paying state, federal, Social Security, Medicare and unemployment taxes for that worker – sometimes with interest – as well as back benefits and, potentially, a fine. If the IRS believes the misclassification is intentional, it can also levy criminal and civil penalties. A professional employer organization (PEO), which offers expertise in compliance, can ensure workers are properly classified, eliminating risk to your company.
2. Mistaking Exempt and Non-Exempt Employee Classifications
You may not think it’s a big deal to accidentally classify an exempt employee as non-exempt, but it is and can leave your company vulnerable to a wage-and-hour lawsuit, and there have been some notable ones in the past like this Fargo-based hotel owner who misclassified employees as exempt. A non-exempt employee is entitled to overtime pay while an exempt worker is not. We break down exempt vs non-exempt employees in more detail here. By misclassifying a non-exempt employee as exempt, they won’t be paid out on overtime wages, regardless of how many hours they work in a given week. Here’s a tip: In general, if an employee performs specific job duties and receives an annual salary in excess of a specific amount, then he/she may qualify as exempt. However, the rules are complex and the assumption that all salaried employees are exempt can be a risky practice for business owners. Consulting with a Professional Employer Organization (PEO) experienced in this area is helpful in order to pay your employees properly and avoid any potential fines.
Key Takeaways When Classifying Employees
Exempt = Not eligible for overtime pay
Non-Exempt = Eligible for overtime pay
W-2 = Employee with a set salary and work expectations
1099 = Contractor who can complete assigned projects in the manner they see fit and request payment according to a billable hourly rate or negotiated project fee
For more on misclassifying employees, check out this article featured in Thinking Bigger written by Axcet HR Solutions' Director of Payroll Administration Jo McClure.
3. Missing Deadlines
Whether it’s payroll or tax payments and filings, it is critical you are on-time. It’s easy to get wrapped up in the day-to-day activities of your business, but when you process payroll late, not only will your workers get upset and lose trust in you, but your business will be at risk for breaking compliance laws. The Internal Revenue Service (IRS) typically requires biweekly or monthly deposits of withholding taxes along with the employer’s portion of taxes. Some small businesses are required to make quarterly estimated tax payments on April 15, June 15, September 15 and January 15. When it comes to taxes, the system is “pay as you go” and believing there is only one tax day each year, on April 15, is bound to get you into some trouble. The IRS adds monthly late payment penalties to any income tax bill or payroll tax deposit that isn’t paid on time.
4. Subpar Record Keeping and Data Entry
A payroll audit isn’t fun, but there’s no need to prolong it, and that’s exactly what happens when you haven’t kept good records. By following state and federal payroll record-keeping laws, you’ll have added peace of mind knowing you have the documentation needed. Federal law requires payroll records to be retained for a minimum of three years. However, the Small Business Association recommends holding on to these records for at least four years. And be sure to check state and local laws as some states require records to be retained for six years. Payroll records to retain include, but are not limited to, W-2s, I-9s, timesheets, expense accounts and pay stubs.
5. Withholding Errors
Calculating taxes is difficult and withholding errors can be abundant. The most common mistakes small businesses make are failure to withhold federal and state taxes, not setting up employees’ tax information correctly, inaccurate pre-and post-tax deduction calculations and making incorrect deductions from exempt employees’ salaries. Be mindful of form W-2. Issuing an incorrect W-2 and providing an employee with a 1099-MISC instead of a W-2 are also common mistakes, along with not having an accountable plan for employee expense reimbursements. Lastly, remember giving gifts to employees can have tax implications. In fact, the IRS views many fringe benefits, such as issuing gift cards as a reward for performance, as taxable and their value should be reported as part of employees’ income.
6. Miscalculating Overtime Pay
The Fair Labor Standards Act (FLSA) requires employers to pay a premium for overtime. Unless employees are exempt, federal overtime provisions require overtime be paid for over 40 hours worked in a workweek at the rate of not less than time and one-half their regular rate of pay. To make overtime pay even more tricky, some states have overtime laws in addition to the federal law. In these cases, the employee is entitled to the higher standard. In fact, one Texas company learned the hard way about the importance of overtime pay. The company made a mistake in overtime pay for an employee’s travel time in the amount of $608.05 in unpaid overtime wages. When it was all said and done, that $600 mistake cost the company over $45,000!
7. Failing to Properly Handle Garnishments, Levies or Child Support
While processing payroll for employees you may encounter court orders for garnishing wages, such as the case for child support payments. In this situation, your business is responsible for withholding the specified amount and sending it to the third party direct.
8. Trying to Handle Payroll Alone
Small business owners may find it tempting to take on their business’ payroll themselves; however, this puts them at risk for extra stress and costly errors. At Axcet HR Solutions, we know payroll is mission-critical for your business. We provide a dedicated payroll administrator to all of our clients. Find out more about our payroll services, tax administration, and payroll compliance services.
Are you inviting an IRS audit? Find out the top five tax mistakes small businesses make.