- Payroll is an important part of running a small business with employees, and getting it right is a key piece of your business’s financial success.
- The payroll process needs to be exact or a business can face serious consequences, from bad financials to unhappy employees and even inquiries from the Internal Revenue Service (IRS).
- Learn more about the top eight most common payroll mistakes and how to avoid them in your small business.
Possible Impact of Payroll Mistakes
Payday should be a day that your employees look forward to, but if you make common payroll mistakes, it can be a headache for everyone. Payroll errors can cost you money, time, and reputation.
Making errors on payroll has an immediate impact on your employees, especially during turbulent economic times like a recession or periods of high inflation. Beyond their ability to pay their own bills and income taxes, employees are more likely to be less productive and may even quit working for you if they aren’t paid on time or to the right standards. An employee may even sue you for incorrectly paying them. You may also earn a reputation as a bad employer, which will make it harder to recruit and retain new employees.
Payroll mistakes can also impact your financial and human resources employees by giving them more work to do. This can cost you in overtime pay — as well as morale.
Another impact of payroll errors on your business is the one it can have on your budget. Overpayment or underpayment can wreak havoc on your books. If you don’t know how much you’re paying employees, you can’t predict how much to set aside for payroll. Missing payments or delaying payments can also affect your cash flow and balance sheet, which can make it harder for you to secure financing for your business.
On top of the human and business impact of payroll mistakes, you may face penalties from the IRS, Department of Labor, or other legal authorities, especially if you miss a filing deadline. Incorrect summaries or filings can mean you miss tax deductions, too. You may also be in violation of the Fair Labor Standards Act (FLSA), which is the federal law that establishes minimum wages, overtime, recordkeeping, and child labor laws in the U.S. Failing to meet any of the standards set forth in the FLSA can lead to fines and possibly even jail time.
The good news is that you can avoid all of these issues with proper payroll management. Managing your payroll correctly allows you to avoid the following most common payroll mistakes.
Most Common Payroll Mistakes
Most payroll mistakes are very common, which means you can look out for them and fix them before they get out of hand. Here are eight of the most common payroll errors that businesses of all sizes make.
1. Payroll tax errors
Filing your payroll taxes correctly and on time is extremely important. Keeping up with monthly deductions and reports can keep you on the right side of the IRS and help you avoid complications from employment taxes down the line.
2. Direct deposit errors
In order for direct deposit to work, the information must be correct. Bad data entry and manual errors can cause delays. You may also face fees from banks for incorrect transfer information.
3. W-2 mistakes
As the most common tax form for U.S. businesses, the W-2 is also the form most likely to have mistakes on it. Filing W-2s on time and with the right departments is important, but it’s also essential to make sure the information is correct. Each incorrect form can cost your business $100 in fines or more. It’s important to verify employee information with new hires to avoid mistakes on W-2s.
There are many W-2 mistakes that can occur, especially when you’re hiring new employees. It’s important to double-check information, such as:
- Full name
- Social Security number
- Selecting the correct checkmark on “Box 13”
- Entering the right Box 12 code
In addition, the IRS has many formatting rules for the W-2, including that it cannot be handwritten and must have the correct font size and ink color. Decimal places must be formatted to include cents, and there cannot be dollar signs before the money amounts.
4. Garnishment mistakes
Sometimes a business owner will need to set aside money in an employee’s paycheck that they owe to a third party, such as the IRS or another legal entity. This is called a wage garnishment, and there are rules about which wage garnishments get paid first and how much an employee is allowed to keep. It’s the business owner’s responsibility to track these deductions and get them right.
5. Overtime calculations
Employee overtime isn’t always as straightforward as getting paid “time-and-a-half” for every hour worked over 40 in a given week. The Labor Department in your state may have specific rules about overtime payment and pay rate, and it’s important to know and follow these state laws. Employee hours need to be recorded properly and rates need to be set right or you could be liable for miscalculations.
6. Missing deadlines
Payroll due dates are an important aspect to processing payroll. Employees need to submit their hours on time, payment information needs to be correct, and financial departments need to have time to run payroll every pay period. And beyond these day-to-day considerations, there are tax filing deadlines that your organization needs to follow.
7. Employee classification
Misclassification can have serious consequences for your payroll. The most common mistake is assuming that “salaried” employees are always “exempt” and “hourly” employees are always “nonexempt”. The FLSA sets the requirements for exemption and non-exemption based around the nature of an employee’s work and other factors. Misclassifying employees as exempt or nonexempt employees can be one major reason your overtime wages are incorrect. It’s also important to know the rules around independent contractors, which are set by the IRS and state agencies. Full-time vs. part-time employees and whether or not the employee is part of a union may mean their pay is governed by different rules as well.
8. Disorganized records
Payroll records need to be organized properly so that you can file at the right time and so your employees get paid promptly. Your state will have rules about how long you have to keep records. Some payroll paperwork that you need to keep and have organized includes:
- Canceled checks
- W-4 forms
You should also have backups, including digital and paper copies, in case something happens.
How Long Do Small Businesses Have to Correct Payroll Errors?
It’s best to correct payroll errors as soon as you know about them, regardless of what your local laws state. Some states allow you to correct underpayment by the next pay period, depending on how big the mistake was, and some will require you to pay the full amount of the wages you owe your employee by a specific day of the month.
If you’ve underpaid an employee, they have two years to find the mistake and ask for you to correct it based on the Department of Labor’s statute of limitations. If you’ve overpaid an employee, the amount of time you have to correct the mistake depends on the state in which you run your business.
How to Avoid These Mistakes and Improve Payroll Management
There are many ways to avoid payroll mistakes. The first is to automate your payroll system through payroll software, which can streamline the process and help you make sure you’re meeting applicable payroll laws. The right payroll software can handle the time-consuming process of determining tax rates, tax withholding, onboarding new hires, and even employee time tracking.
You may also consider a professional payroll service to outsource the process. A payroll provider can help navigate tax laws, employee classification issues, and make sure you hit important deadlines.
Many accounting software solutions will also have a payroll solution, or will integrate with the payroll service you use. It’s important to take several factors into consideration when choosing the right accounting software for your business, such as which aspects of payroll it can automate and its pricing structure. Learn more about payroll services with Nav’s payroll software resources.