The 7 Most Common Payroll Mistakes

IRS regulations require businesses to make the following payroll tax deposits on either a monthly or semi-weekly schedule:

• Withheld federal income tax
• Both employer and employee Social Security and Medicare taxes

Consult IRS publications before the beginning of each calendar year to determine whether you are required to make deposits on a monthly or semi-weekly schedule.

The Federal Unemployment Tax Act further requires any unemployment taxes above $500 to be deposited quarterly (due at the end of the month following the quarter).

You must electronically remit federal tax deposits. Pay late, and you’ll face penalties, with fines reaching as high as 15%.

In addition to federal obligations, you might be required to make state payroll tax payments for income taxes and unemployment taxes. Regulations vary by state.

Solution

For federal payroll tax payment schedule requirements, consult the IRS Employer’s Tax Guide, Publication 15 (Circular E). For state requirements, consult your state’s department of revenue. Because IRS and state instructions can be complicated, many companies find it best to hire a tax professional to set up payroll payments.

The easiest way to avoid payroll mistakes and make sure your payments are on time is to schedule automated electronic payments. You can schedule automated payments through the Treasury Department’s Electronic Federal Tax Payment System. Your state department of revenue might also offer automated electronic payment options.

The IRS keys payroll tax records to employee Social Security numbers (SSN), so entering incorrect SSN data can cause headaches. You could waste valuable hours correcting data entry errors, paying extra labor and fines in the process.

Solution

The Social Security Administration provides a Social Security Number Verification Service you can use to confirm worker information. The service offers options both for verifying your entire payroll database or for verifying up to 10 names at a time. This tool is useful for processing new hires. Making this a part of your onboarding process will save you time and money.

For payroll purposes, workers fall into 2 categories:

• Employees who must be paid minimum wage may be eligible for overtime and must have taxes withheld from their wages
• Independent contractors who are not entitled to minimum wages or overtime and do not have taxes withheld

Some employers deliberately misclassify employees as contractors to avoid paying overtime or benefits. Because of this, the Department of Labor and the IRS are particularly vigilant about penalizing employers who take this action. Misclassifying a worker can result in fees, penalties, back taxes and legal action.

Solution

If you’re not sure whether a worker should be classified as an employee or independent contractor, the Department of Labor provides a test to help make this determination:

1. How integral is the worker to your company? For example, do they do the primary type of work you perform for your customers?
2. How permanent is the worker’s relationship with your company? How long have they worked for you?
3. Is the worker invested in your company’s facilities or equipment? Do they use their own equipment?
4. How much control does your company have over the worker? For instance, do you set their hours, or do they work on their own schedule? Do they work for any other companies besides yours?
5. How much opportunity does the worker have for profit or loss? Can they earn more by doing their job more efficiently or exercising managerial skills? Are they invested in insurance or bonding?
6. How much skill and initiative does the worker require to do their job? Do they perform routine tasks that require little training? Does the worker solicit their own business through a website or advertising?

In general, if your answers indicate a worker has more autonomy and independence over how they perform their role and interact with your company, you should classify this person as an independent contractor.

For example, you might set deadlines and requirements for a worker’s assignment or project, but you won’t assign their daily schedule as you would for an employee. Independent contractors will also usually utilize their own equipment, not your company’s, and aren’t eligible for benefits. Your company’s relationship with an independent contractor is limited to the duration of a project or their contract. They may also work with other businesses.

If you’re still unsure how to classify a worker, avoid a payroll discrepancy by filling out Form SS-8 and asking the IRS to make the determination for you.

If a worker is classified as an employee and earns less than $684 a week ($35,568 a year), they are normally eligible for overtime under the Fair Labor Standards Act (FLSA) when they work more than 40 hours a week. Note that certain jobs are excluded from the FLSA, such as specific agricultural workers and movie theater employees.

In addition to FLSA regulations, state regulations may determine an employee’s exempt status.

Some employers deliberately miscalculate overtime to avoid paying it. As a result, tax authorities penalize overtime misclassifications and payroll mistakes such as deliberate underpayment. Failing to calculate overtime correctly can cost you in back wages, back interest and penalties.

Solution

In most circumstances, you can determine whether an employee is exempt from overtime by applying 2 simple tests:

• Salary level test: Do they earn less than $684 a week ($35,568 a year)? Note, this includes salaried/exempt employees.
• Duties test: Do their job duties involve high-level executive, professional or administrative tasks, such as supervising 2 or more employees?

The duties test can sometimes be challenging to apply, so the Department of Labor provides fact sheets with more details to help you determine whether an employee is exempt. Check your state overtime laws with your state’s department of labor as well.

The FLSA requires employers to maintain accurate payroll records identifying information about non-exempt workers, how many hours they worked and how much they earned. Those records must include:

• Employee name and Social Security number
• Employee birth date
• Employee sex and occupation
• Employee address
• Basis of employee’s wage payments (for example, $15 per hour)
• Regular hourly pay rate
• Time and day when employee’s workweek begins
• Hours worked each day
• Total hours worked each week
• Total daily or weekly straight-time earnings
• Overtime earnings
• Wage additions and deductions
• Total wages for each pay period
• Date of each payment and pay period covered

Employers may preserve these records in any form they choose, as long as the information is maintained.

Payroll records must be preserved for at least 3 years under the FLSA. And records used as a basis for calculating wages, such as work schedules and time cards, must be preserved for 2 years. State regulations may impose additional record-keeping requirements.

Solution

Use a standard form for documenting required payroll information, and make it part of your standard operating procedure to fill out and file your payroll form. The easiest way to do this is to adopt a payroll software app that automatically captures the required data.

Use file backup procedures to ensure you retain the necessary documents for the required length of time. Automating your computer backup procedures with a cloud backup service can assist with this task.

Make sure your records filing procedure complies with both federal and state law. Outsourcing to a payroll service provider can help ensure that your records comply.

Payroll tax rates continuously change, and failing to keep up with them could lead you to use outdated tax tables and accidentally create a payroll discrepancy. Tax rates subject to change include:

• Federal income tax
• Social Security tax
• Medicare tax
• Federal unemployment tax
• State income and unemployment tax
• Local income tax

Payroll mistakes in these areas can cost you in fees and penalties as well as extra labor to correct errors.

Solution

The best way to stay current with the latest tax tables is to make sure your payroll software does automatic updates to reflect recent changes. 

A payroll outsourcing service can also help you keep up with tax changes. If you choose to manage updates manually, check the IRS website at least once per year for the latest rates.

Federal regulations require employers to send employees and independent contractors annual forms summarizing what wages they received and what taxes were withheld from them. The 2 primary forms are the following:

• W-2 forms are sent to employees
• 1099-MISC forms are sent to independent contractors

These forms must be sent to workers by the end of January. Copies must be sent to the IRS by the end of February. Penalties apply for both late and incorrect forms as well as illegible forms.

Solution

Make sure your tax filing standard operating procedure includes sending out W-2 and 1099-MISC forms on time. Working with a tax professional will help ensure that this task gets done before the deadline. If you’re handling this on your own, set up calendar reminders well in advance of the deadline.