Payroll is one of the most important aspects of any business, but when it’s running smoothly, business owners don’t tend to think about it much. However, when there’s a payroll glitch, it jumps to the forefront of an owner’s mind. Here are several payroll mistakes that can cost you a bundle — and how to avoid them in your business.
1. Misclassifying Employees
How you classify employees when you hire them impacts how you and your employees are taxed. If you hire an office staffer to answer phones and file paperwork for an hourly wage, that is a non-exempt employee. Alternatively, if you employ an individual as a salaried Head of Operations, that person is exempt. The main difference is that non-exempt employees are eligible to receive overtime pay; exempt employees are not.
There is also a distinction between employee, freelancer, and contractor. An employee receives a regular wage, while freelancers and contractors are typically paid per project. Misclassifying employees may not seem like a big deal at first — but in time, the IRS will find out. Then your business will end up paying the taxes due, the associated fines, and of course, the interest on the past-due taxes.
To avoid this issue, understand the classifications and the capacity in which you hire your employees. To classify employees, be sure to use IRS definitions. For example, the IRS defines independent contractors this way: “the general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”
2. Miscalculating Pay
There are many payroll aspects to consider, such as overtime, commissions, deductions, paid time off (PTO), and more. When it comes to calculating pay, payroll admins should keep in mind that different policies apply to each state, which must also be considered. For example, the federal overtime law dictates that overtime wages (pay for hours worked over 40 hours in a workweek) are paid at 1.5 times an employee’s regular hourly rate. However, some states have different policies regarding overtime. For example, in Alaska, California, Colorado, and Nevada, overtime is also based on hours worked in a day. As a general rule, a business should comply with the more generous law for the employee.
In addition to overtime pay miscalculations, poor time tracking capabilities also contribute to miscalculated pay. To avoid an issue of miscalculating pay, be sure to know your state’s guidelines on overtime. Further, be sure that your company has a reliable tracking system for keeping up with employee hours so that pay, overtime, and other payroll aspects like PTO are correctly recorded and calculated. This process will significantly reduce the chance of payroll overpayment or underpayment mistakes that could become costly payroll corrections.
3. Missing Deadlines
One of the most damaging payroll mistakes for a business is missing payroll tax deadlines. Missed deadlines can cost thousands of dollars in penalties, and in extreme cases, a company’s business license can be suspended.
To avoid this critical error, use the IRS Calendar Connector to help you remember your tax deadlines. However, if you miss a tax deadline, contact the tax agency immediately because late payment penalties pile up quickly. The quicker you get in touch with the IRS, the less penalty you will have to pay.
4. Messy Recordkeeping
What is the word a small business owner least likes to hear? There are likely a few, but “audit” has to be right at the top of the list. The anxiety induced by a threat of audit should be reason enough to keep accurate, complete, well-organized payroll records. The price you pay for not keeping good records could include fines, penalties, and a plethora of costly payroll-related tax issues. For example, if you accidentally file W-2 forms late, you will pay between $50 and $260 in fines per W-2 form, depending upon how late the W-2s are filed.
The same goes for late-filed 1099 forms or any other tax-related documentation. The fines vary. For example, if you do not provide a contract employee with a 1099 form, that’s a $250 fine.
To avoid these issues, keep accurate, complete, up-to-date payroll records for all employees and contractors. Mind your paperwork like W-2 forms, timesheets, 1099 forms, and pay records. Also, be sure to retain employee records for the four-year minimum that the IRS requires after an employee leaves your company. FYI: The SBA recommends retaining payroll records for six years.
5. Missed Tax Forms
Another crucial recordkeeping issue targets an end-of-year task that some payroll admins dread — preparing and sending out all the necessary tax forms to all workers, whether they are full-time (W-2), part-time (W-2), or independent contractors (1099). Remember, form 1099 is required to be sent to an independent contractor who earned $600 or more during a tax year.
To avoid this issue, make sure tax rates are in order, payroll is correctly calculated, and all forms are correctly filled out and sent to employees promptly. IRS requires that W-2s and 1099s must be postmarked by January 31st. If January 31st falls on a weekend, then the filing deadline is moved to the next business day.
Payroll-related tax issues are avoidable. Take time to speak to your trusted tax preparer or CPA today so that you avoid these mistakes and keep your business running as it should.
Baum CPA is the kind of trusted tax preparer you should be looking for. Click here to schedule an initial consultation with us today.
This blog and its authors provide this content strictly for informational purposes. No content herein should be misconstrued as financial advice. Everyone’s specific circumstances vary — Always consult with a qualified, licensed financial advisor, legal counsel, and tax professional before venturing into any investment or business activities.