5 Payroll Mistakes And How to Avoid Them

Payroll systems have come a long way in the past 10 years. Depending on the type of your business, there might be no need to manually enter the hours worked thanks to the time-tracking tools integrated with the payroll software. And with the direct deposit function, you don’t have to print paper checks anymore. It is, indeed, convenient, but this payroll automation can also be a dangerous thing. Not only can software fail, but removing a human supervisor also opens your payroll system to all sorts of errors and miscalculations. As Maryland payroll specialists, we have helped many clients fix and avoid several costly payroll mistakes.

Denying Overtime Compensation

“We don’t pay overtime” is not a company policy. Overtime is covered by the employment law and is not up to the employer to offer or deny. It’s a common misconception that salaried employees are not eligible for overtime. Overtime eligibility is primarily determined based on the employee’s duties and role in the company. Some of your employees might be exempt while others may be eligible to receive 1.5 their regular rate for hours worked in excess of 40 a week. Note also that overtime is calculated on a weekly basis (or daily in some states)—not based on the bi-weekly pay period.

How to avoid: Consult with an employment lawyer or your local payroll specialist before adding any new employees to the payroll.

Misclassifying Employees

The two main categories of employees are W-2 payroll employees and 1099 independent contractors. Similar to the issue with overtime, this classification is not something that is decided between the two parties—it is outlined in the law. If an employee works on your premises, uses tools provided by you, adheres to your schedule and procedures, he or she is likely not an independent contractor. When a misclassification occurs, it usually leads to thousands of dollars in state and federal taxes owed to the IRS.

How to avoid: If you are unsure about how to classify new or existing employees, talk to an employment lawyer or a Maryland tax professional. You can reclassify your wrongly determined independent contractors as employees with a partial relief from the owed taxes though the Voluntary Classification Settlement Program.

Not Checking the Numbers

Your employees trust you to pay them the right amount and you trust your software to calculate that amount for you. Do you see a potential problem here? If you let the payroll software do its job without checking in on it and verifying the accuracy, you risk creating a huge headache for yourself. The technology can glitch or you could have entered wrong parameters to begin with—the earlier you catch a mistake, the better. Something as simple as recording 2 hours and 30 minutes as 2.3 instead of 2.5 can snowball into massive underpayment, but it’s also something a trained eye would pick out.

How to avoid: If you are doing payroll in-house, have a payroll specialist verify that you have set it up correctly. Outsourcing your payroll to a professional can also be a good strategy.

Overlooking Taxable Fringe Benefits

As you might know, fringe benefits are forms of non-monetary employee compensation, such as health insurance, education reimbursement, life and accident insurance, etc. Many of these benefits are tax-free and don’t need to be reported as income. However, some of them are taxable, including but not limited to awards, prizes, moving expenses and personal use of the company car or cell phone. Failing to include the cash value of these benefits in the employee’s taxable income may lead to IRS penalties and force your employees to re-file their taxes.

How to avoid: Understand which benefits are taxable and which are not. Consult with your CPA when in doubt.

Poor Organization and Record-keeping

If you have handled your company’s payroll at any point in life, you know why accuracy, timeliness and good organization are important. Miscalculated hours, incorrectly entered names and social security numbers, outdated employee records and delayed tax payments are just some of the issues that can get you in trouble with the IRS. Payroll involves quite a bit of paperwork and it’s crucial that it’s done right and timely.

How to avoid: Have a designated payroll specialist who can focus on this one task rather than being pulled in all directions by your growing business needs.

Why Payroll Mistakes are Dangerous

So you overpaid or underpaid your employee on a few occasions—what’s the big deal? Even the smallest mistakes can lead to some undesirable consequences.

• Shattered trust. Consistent payroll mistakes may ruin the trust and respect of your employees. They might think you are either trying to pocket their hard-earned money or you are incompetent as a payroll administrator.
• Wasted time. Depending on how soon you catch the mistake, it may take hours if not days of going through all the records, finding where things went wrong and fixing it.
• IRS penalties. Payroll falls under the tax law and in the event that an audit uncovers violations, you may be subject to significant penalties and audit costs.

Because payroll is a recurring and semi-automated process, any mistakes made in setting it up have a tendency to snowball really fast. In a matter of weeks you may end up with thousands of dollars in owed taxes or overpaid wages. CFOSource is a Maryland business consulting firm specializing in tax planning, accounting, payroll and other business services. We can help you set up your payroll, understand your business taxes or even process payroll for you, so you can worry about more important things. Give us a call at 410-242-0526 or contact online to talk about how we can help.