So, what are some common payroll mistakes businesses make? My list below will help you know what to watch out for as you process payroll for your employees.
1. Miscalculating Employees’ Pay
This can happen for various reasons, such as tracking time inaccurately, not applying overtime rates correctly, using the wrong wage or salary rate, or not applying the correct withholdings and deductions. As you can imagine, incorrectly paying employees can upset workers and create numerous ripple effects, as even the most minor error can affect monies reported and remitted to the IRS, states, local governments, health insurance companies, retirement plans, and more.
Each step of calculating an employee’s take-home pay needs careful scrutiny to ensure accuracy:
- Gross Pay – An employee’s gross pay is calculated using their hourly wage multiplied by the hours worked (or salary) and any tips received. Gross income also includes any bonuses earned. Any overtime hours must be calculated using the correct overtime pay rate.
- Pre-Tax Deductions – Deductions not subject to tax, such as 401K contributions and health insurance premiums, should be subtracted from the employee’s gross pay.
- Tax Deductions – After subtracting pre-tax deductions from gross pay, the employer must deduct applicable taxes from the adjusted amount.
- Other Deductions – Next, additional voluntary and court-ordered withholdings should be deducted.
- Net Pay – The money remaining is the employee’s take-home pay.
2. Misclassifying Workers
Employee vs. contractor? Employees are on payroll; contractors are not because they are in business for themselves.
Employees enjoy many labor rights and protections that contractors do not, such as:
- Access to unemployment insurance and workers’ compensation benefits
- Employer contributions to Social Security and Medicare
- Minimum wage, overtime, anti-harassment, and discrimination protections
- Right to organize and bargain collectively
If a company doesn’t classify workers correctly, it can face some major headaches, including:
- Regulatory investigations
- Worker lawsuits
- Payment of back pay (straight time and/or overtime), back payroll taxes, retroactive benefits, and retirement contributions
- Penalties and interest
- Loss of the business owner’s personal liability protections
Note that workers do not choose how they are classified. The IRS has rules that dictate whether someone should be classified as an employee or independent contractor, and some states, like California, have even more stringent classification laws.
3. Not Withholding, Reporting, and Remitting Taxes
Besides federal tax (federal income tax withholding, Social Security tax, Medicare tax, and federal unemployment tax), state and local taxes may also apply.
Employers must withhold federal income tax from employee pay based on information provided on their W-4 forms, and employers must withhold half of an employee’s obligations to Social Security and Medicare taxes (FICA) from the worker’s pay (the employer is responsible for paying the other half).
Many states have a personal income tax that must be deducted from employees’ pay, and all states require most employers to pay a state unemployment tax (SUTA). In most states, SUTA is paid solely by the employer, with no portion withheld from employees’ pay.
Additionally, some counties and cities charge local income taxes. State and municipality laws vary, so research the requirements and talk with a tax professional for guidance if you’re uncertain about the employment-related taxes you are responsible for.
4. Botching Other Withholdings and Deductions
Employees’ contributions to voluntary benefits such as 401K, health care plan, union dues, group life insurance, disability insurance, or charitable giving must also be withheld from their pay. In some instances, there might be deductions from pay mandated by a court. Examples include child support, loan payments, unpaid taxes, and alimony.
5. Failing to Get Workers’ Compensation Insurance
Workers’ compensation laws, which require employers to pay insurance to cover expenses when employees are injured or become ill as a result of their work, vary from state to state. In some states, employers must purchase insurance from a state fund, while in others, businesses can buy it from an insurance carrier, agent, or broker. A company might suffer significant penalties, such as hefty fines or even prison time, if it does not obtain workers’ compensation insurance if it’s required.
6. Ignoring Out-of-State Payroll Tax Obligations
With more remote employees in the workforce, this is something many businesses need to keep in mind. Usually, the income and payroll tax requirements where an employee lives and works apply when an employee doesn’t live in the same state as their employer. That means the employer must register with that state’s tax agency, apply for a state income tax withholding number, obtain an unemployment insurance number, and withhold state income taxes (possibly local, too) from the remote employee’s pay.
If an employee lives in one state and works in another, the employer may need to withhold state income and payroll taxes for both states from the worker’s pay. However, if a state reciprocal tax agreement is in place between the two states, the employee can request an exemption from state income tax in the state where they work. In that instance, an employer would withhold state income tax only for the state where the employee lives.
A company formed as a business entity (e.g., LLC or Corporation) may need to register as a foreign entity (known as foreign qualification) in the state where its remote employees work. Whether an entity must foreign qualify in the state depends on whether the employer has nexus in that state. A foreign-qualified company must fulfill the compliance requirements of not only the business’s home state but also those of the state where it has registered as a foreign entity. Examples of compliance requirements include designating and maintaining a registered agent in the state, obtaining licenses and permits, filing annual reports, collecting and remitting sales tax, paying income taxes, and withholding and remitting payroll taxes.
7. Missing Deadlines
As you can imagine, timing matters! Failing to meet payroll reporting and deposit deadlines can lead to fines, interest, and other penalties. Employers’ federal deadlines are on either a monthly or semi-weekly schedule, based on the total tax liability previously reported during the specified lookback period. It’s important for business owners to determine which schedule applies to their company before the beginning of the calendar year so they know when their deposits are due.
Deposit deadlines for state and local payroll taxes vary.
8. Attempting It Without Help or a Payroll System In Place
Payroll is too important to entrust to someone who doesn’t fully understand payroll requirements or who is disorganized. Inexperience, sloppy record-keeping habits, and lack of attention to detail can put a business at risk of fines, penalties, and even legal issues. And manual payroll processing creates a greater chance of errors and omissions that can have costly consequences. I recommend that business owners consider hiring or contracting a payroll or accounting professional to manage their all-important payroll functions and subscribing to payroll software that can automate aspects of the process to lessen the risk of costly errors.
Other Payroll-Related Resources
- What Is Payroll?
- What Are Payroll Deductions?
- What Are Payroll Taxes?
- What is FUTA?
- What is FICA?
- Is State Unemployment Insurance Required?
- Registering for Payroll Taxes
- What Is Payroll Processing?
- Setting Up Payroll for an LLC or Corporation
- Tax Registration: What Your Business Needs to Know
- How Do You Pay Yourself as a Sole Proprietor?
- How Do LLC Owners Get Paid?
- How to Manage Payroll for Restaurants
- Hiring Family Members in a Small Business
- Hiring Remote Employees in Another State
- Legal Requirements for HIring Out-of-State Employees
- Independent Contractors vs. Employee
- What Every Small Business Should Know About 1099s
- State Timelines & Delivery Methods Guide
CorpNet Makes it Easy!
CorpNet is here to help you get your payroll in good order from the start. We can quickly register your business for state income tax and state unemployment insurance tax. Our specialists manage the process to make it hassle-free for you, so you can focus on growing your business.
