Financial well-being January 25, 2024 By
Whether you have one employee or hundreds, effective payroll protocols are vital to the success of your mission and team.
When best practices aren’t followed, expensive errors can be compounded with fines and legal troubles.
Here are seven payroll pitfalls to avoid:
Misclassifying Employees
Treating nonexempt employees as exempt – or employees as contractors – can result in severe penalties.
Nonexempt workers are entitled to at least minimum wage and overtime pay, while exempt workers are paid a salary above a specific level and aren’t compensated for overtime. Contrary to popular belief, it’s not just about whether a worker is hourly or salaried – it’s a multipronged test. In the U.S., the Fair Labor Standards Act (FLSA) sets the basic rules, while your state’s labor department may establish stricter standards. Consult both sources – and get advice from an experienced employment attorney if you’re in doubt.
Likewise, employees are covered by a range of labor and tax laws that don’t apply to independent contractors. The FLSA, IRS, and state labor and revenue departments offer essential guidance on this topic.
Miscalculating Pay
Time-tracking errors and misunderstandings about breaks and meals can lead to fines and backpay claims.
Unclear clock-punching protocols and careless clerical errors can lead to overpayment or underpayment of wages or paid time off (PTO). Mistakes that result in the miscalculation of overtime can be especially costly and time-consuming to fix (usually, nonexempt employees are entitled to time-and-a-half pay if they work over 40 hours in a workweek). It’s also important to understand how rest and meal periods work. At the federal level, meal periods of 30 minutes or more may either be paid or unpaid, but short breaks are generally compensable and count towards weekly totals.
Employees can recover lost wages two years after the fact – with hefty penalties and interest added – so it pays to be proactive and double-check your work.
Applying Incorrect Tax Rates
Tax rates and policies change frequently, so either stay informed and stay up to date – or use a reliable payroll service.
Generally speaking, employers are responsible for withholding and remitting federal, state, and local income taxes, plus payroll taxes for Social Security, Medicare, unemployment, and sometimes disability insurance. These rates and thresholds change yearly, and tax codes (comprising several thousand pages) can change anytime.
Unresolved errors can result in penalties from tax authorities, and if remedying an error involves adjusting future withholdings, this can cause cash flow issues for your employees. That’s one of the main reasons many busy small business owners opt to use specialized payroll software or outsource the whole process.
Missing Deadlines
Employers need to adhere to their chosen payroll schedule (weekly, biweekly, semimonthly, or monthly) as well as to keep track of due dates for payroll tax returns and deposits.
Per the IRS, nonagricultural businesses with annual employment tax liabilities of $1,000 or more must report wage and tax payments on a quarterly basis. In addition, most employers must also file a separate annual tax return to report wage payments subject to federal unemployment tax. Then, there is a different set of deadlines for depositing income and payroll taxes.
If you miss these deadlines – even by a day or two – you could be charged fees and interest, and repeat offenders may come under increased scrutiny by auditors.
Forgetting to Send Out Tax Forms
The start of the year is often a busy time, but it’s important to remember to prepare your W-2s and 1099s.
W-2 forms go to all employees, and 1099-NEC forms go to independent contractors who have been paid $600 or more for the year (note that 1099-MISC forms are not used for contractors). W-2s and 1099s are typically due to recipients and the IRS on January 31 or the next business day. State filing deadlines may vary.
While you won’t have all the financial data until the end of the year, it’s wise to confirm mailing addresses and other information ahead of time.
Neglecting Payroll Records
Nobody likes getting audited, but keeping your paperwork organized can make the process a lot less painful.
Employers must maintain specific records for each worker, including hours worked and wages earned. In addition, the U.S. Equal Employment Opportunity Commission (EEOC) requires the retention of certain payroll- and benefits-related information to comply with federal anti-discrimination laws. It’s also a good idea to hold on to invoices and other communications from independent contractors that prove they are, in fact, contractors and not misclassified employees. Records should generally be kept for a minimum of four years, depending on the state.
Keep physical payroll records in locked cabinets and use secure cloud storage solutions to deter unauthorized access or tampering.
Ignoring Signs of Fraud
Business owners need to proactively guard against payroll fraud perpetrated by employees or third parties.
Employee payroll fraud can take many forms, from “buddy punching” (when one worker clocks in on an absent worker’s behalf) to “rate rigging” (where an employee with access to your payroll system increases their hourly wage right before payday and reverts it right after). Meanwhile, international cybercriminals have been known to gain access to payroll software and reroute direct deposits into offshore accounts. In all these cases, a penny of prevention is worth a pound of cure.
Be sure to implement checks and balances within your organization and enable multifactor authentication for all sensitive HR and accounting data.
