Common Payroll Mistakes to Avoid for US Businesses

Oliver Lee
August 3, 2022
 Mins Read

Operating a business is challenging, and in the process, it is important to keep all stakeholders satisfied, particularly employees. While a good working environment and comfortable infrastructure are critical, the best way to keep employees happy is to ensure that they are financially rewarded for their efforts.

In this regard,an efficient and effective payroll management system is essential. This is the key to ensuring that employees are paid correctly at the right time. However,as your organization grows, it might be challenging to manage the payroll process without errors. Such errors can make your staff distrustful, and their job satisfaction levels might be allowed. Below are some common payroll mistakes businesses in the US make. Understanding and avoiding them can help prevent employee dissatisfaction.

Most Common Errors in Payroll Processing

1. Delay in Payroll Processing:

Once your company bank account has been verified, you can start processing payroll.Before you do that, identify the exact days required to process your payroll on time. It is also important to understand when your account will be debited, as this is needed to reconcile all the funds that cover payroll transactions.

There are many issues if payroll is not processed on time. Personnel usually have their bills on auto-pay, and their accounts will end up overdrawn unless they are paid on time. Add to this employee dissatisfaction, leading to a drop in productivity once the salary is credited to their accounts. You should run your payroll 3-4 business days before your employee's payday. Bank accounts would be debited the following day after you process payroll. In the next two days, funds will reach your employees' accounts. Most often, businesses need to pay more attention to the time needed for this process, resulting in a delay in giving salaries to employees.

2. Improper Payroll Set-Up:

Many errors occur because payroll is set up incorrectly. When setting up your payroll, you must incorporate several aspects, including taxes, reimbursements, and employee classifications. Your payroll will be accurate if you still need to register your business, set up federal, state, and local tax with holdings, classify employees correctly, or deposit taxes on time. The tax authorities could levy penalties.

To file taxes accurately, it is imperative to study the law and understand how much to with hold from employees in case of federal and state income taxes, social security, and other taxes. You also need to understand how much you, as an employer, will pay in taxes. Failure to incorporate the right payroll laws into the system can put the business at risk during tax preparation and filing.

3. Classification of Employees:

Incorrectly classifying an employee can expose you to wage and hour audits and significant penalties if found guilty of the wrong classification. For example, employees are generally classified as either employees or independent contractors.Getting this classification right is critical. This is because, based on this classification, compensation gets reported to the tax authorities.

A worker's entitlement to benefits, such as medical insurance coverage, retirement plan benefits, and equity compensation, hinges on their status as an employee. This status would also determine whether he should be subject to federal income tax and employment tax withholding. A tax liability comes into effect upon reclassification (due to the wrong classification).

4. Backup Withholding:

In the US, you must obtain a Form W-9 before issuing payment to vendors. If you issue a vendor payment without obtaining a Form W-9, there is a mandatory backup with holding at a 28% rate for such a payment. The issue would persist if you later find out that the vendor is not subject to backup withholding (for example, if you find out later that the vendor is a corporation). If the IRS finds out that you did not obtain a Form W-9 before issuing payment, you might have to pay a failure-to-deposit penalty on the amount that should have been withheld.

5. Incorrect Payment:

With the pressure of operating a complex business in a streamlined manner, there could be a possibility of incorrect payment to employees. The solution would be to execute a trial run of your payroll in good time for the due payment date.Request your payroll provider to give you a list of dates on which payments should be made so that you get all payments. Using the wrong tax code could also lead to over payment, resulting in the employee having to return the excess amount. This scenario will reduce goodwill for the company and be avoided at all costs.

6. Improper Records:

Even if it might not matter to your staff, remember that pay slips and P60 forms may be needed by them years later. Most employers need to archive these details. Recording information is crucial and might help avoid penalties when there is an audit by IRS. In addition, there are times when you use paper checks to reward your employees. For instance, you might have rewarded your staff with a bonus at Christmas or the end of the tax year. Whatever the mode of payment, a record must be maintained in the payroll system.

7. Exclusion of Awards, Reimbursements, and Gifts:

For federal income tax purposes, awards and prizes must be considered taxable fringe benefits. Therefore, they must be subject to federal income and employment tax withholding. Gift cards issued to staff are the equivalent of cash and should always be included in taxable pay regardless of the amount. Expense reimbursements can be excluded from an employee's wages only if reimbursed according to an accountable plan. This plan usually reimburses employee expenses only if there is a business connection to the expenditure.

The expense must be adequately accounted for and should be submitted along with proper documentation. If expenses reimbursed do not come under this umbrella, they must be included in taxable wages. Spousal travel, company-provided vehicles, and housing benefits are counted among taxable fringe benefits. Businesses must use the right valuation methods to calculate these expenses and consequently, taxes and withholdings.

8. Form W-2 Errors:

Usually,businesses are required to furnish copies of Form W-2 to every employee by January 31. This form would list their total wages and deductions for the prior year. The form must be properly addressed and mailed to the employees on or before the due date.

The filing deadlines for state and local government agencies might vary, depending up on your filing method (electronic or paper). Therefore, care should be taken while filling out the form, and the employee verification service may be consulted for guidance.

9. Errors in Calculating State Unemployment Tax:

The United States Social Security Act of 1935 requires all states to set up unemployment compensation programs. Failure to pay state unemployment tax on time could result in a loss of federal unemployment credit at the end of the year. Also,businesses may erroneously pay this tax at the wrong rate. Businesses also need to remember that some states, such as Alaska, New Jersey, and Pennsylvania,have employee-paid and employer-paid taxes.

10. Not Considering Other Laws:

With changes in the Affordable Care Act (or Obamacare) and other upcoming legislations, health insurance laws must also be considered for preparing payroll to avoid penalties at the time of filing.

The consequences of incorrect payroll processing can be considerable for businesses of all sizes. Particularly related to small businesses, it is important to remember that 40% of such enterprises pay close to USD 1,000 yearly in penalties due to payroll mistakes. This can be avoided by maintaining accurate payroll, having sound finance and accounting practices, and a seamless tax preparation system.

Article by
Oliver Lee

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