Common Payroll Mistakes to Avoid for US Businesses

Common Payroll Mistakes to Avoid for US Businesses

Operating a business is a challenging task, 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 the right amount at the right time. However, as your organization grows, it might be challenging to manage the payroll process without errors. Such errors can lead to your staff becoming distrustful and their job satisfaction levels might take a hit.

Listed below are some of the common payroll mistakes that 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 number of days required to process your payroll on time. It is also important to understand when your account would 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 if they are not paid on time. Add to this employee dissatisfaction, leading to drop in productivity until the salary is credited to their accounts. You might typically need to run your payroll 3-4 business days prior to your employee payday. Bank accounts would be debited the following day after you process payroll. In the next 2 days, funds would reach your employees’ accounts. Most often, businesses miscalculate the time needed for this process, resulting in a delay in giving salary to employees.

  1. Improper Payroll Set-Up:

    Many errors occur because a payroll was set up incorrectly. When setting up your payroll, you would need to incorporate several aspects, including taxes, reimbursements and employee classifications. If you have not registered your business as yet, set up federal, state and local tax withholdings, classified employees in the right manner, or deposit taxes on time, your payroll will be inaccurate, and the penalties could be levied by the tax authorities.

    In order to file taxes accurately, it is imperative to study the law and understand how much to withhold 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 at the time of tax preparation and filing.

  1. Classification of Employees:

    Incorrectly classifying an employee can expose you to wage and hour audits, as well as significant penalties if found guilty of wrong classification. 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 his or her status as an employee. This status would also determine whether he should be subject to federal income tax and employment tax withholding. Upon reclassification (due to wrong classification), a tax liability comes into effect.

  1. Backup Withholding:

    In the US, it is critical that you obtain a Form W-9 before issuing payment to vendors. If you issue a payment to a vendor without first obtaining a Form W-9, there is a mandatory backup withholding at a 28% rate for such a payment. The issue would still 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 prior to issuing payment, you might have to pay a failure-to-deposit penalty on the amount that should have been withheld.

  1. 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 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 do not miss payments. Using the wrong tax code could also lead to over-payment, resulting in a situation where the employee would have to return the excess amount – a scenario that will reduce goodwill for the company, and to be avoided at all costs.

  1. Improper Records:

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

  1. Exclusion of Awards, Reimbursements and Gifts:

    For federal income tax purposes, awards and prizes must be considered as taxable fringe benefits. 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 he or she is reimbursed according to an accountable plan. This plan is usually one wherein employee expenses are reimbursed 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 with holdings.

  1. 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 upon your filing method (electronic or paper). Care should be taken while filling the form and the employee verification service may be consulted for guidance.

  1. Errors in Calculating State Unemployment Tax:

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

  1. Not Considering Other Laws:

    With changes in the Affordable Care Act (or Obamacare) and other upcoming legislations, health insurance laws must be taken into consideration as well 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 a year in penalties due to payroll mistakes. This can be easily avoided by maintaining accurate payroll, having sound finance and accounting practices in place and a seamless tax preparation system.

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  1. Nice article , I learned a lot from the specifics – Does anyone know if my company can grab a fillable SSA SS-5 copy to fill out ?


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