Without a proper payroll system in place, your business can incur unnecessary costs and even run the risk of an IRS audit. That being said, we’ve identified the top 7 payroll mistakes that small business owners make and how you can avoid them.
Incorrectly classifying workers
The people who work for your company are either employees or independent contractors. Worker classification is critical because it determines whether an employer must withhold income taxes and pay Social Security, Medicare taxes and unemployment tax from an employee’s compensation. On the other hand, businesses are generally not required to withhold or pay any taxes on payments to independent contractors, who are subject to self-employment tax.
How do you determine whether a worker is an employee and not an independent contractor? The IRS recommends considering the following three factors:
- Behavioral: A worker is deemed an employee if the business has the right to instruct and control the duties carried out by the worker. A good example of a behavioral factor is whether the business can dictate when and where the worker can perform his or her work.
- Financial: One important consideration is the mode and frequency of payment. An independent contractor usually charges a flat fee or, as is the case in some professions, they may be paid hourly. On the other hand, an employee is usually paid on a fixed schedule (more on required pay frequency for employees later in this article).
- Relationship: The permanency of the relationship is an important determinant of worker classification. An expectation that the relationship will only exist until the completion of a specific project is a good indication that the worker is an independent contractor and not an employee.
If you have incorrectly categorized workers, the Voluntary Classification Settlement Program (VCSP) allows some eligible businesses the option to reclassify their workers as employees with partial relief from federal employment taxes.
For more information on properly classifying workers, visit the IRS website here.
Failure to issue 1099s
If you exceed the IRS’ threshold of $600 in cumulative payments to independent contractors for a tax year then you must complete Form 1099-MISC Reporting for Nonemployee Compensation which is due by January 31st. As a best practice, you should collect W-9 information when you begin an engagement with an independent contractor.
Getting employee details wrong
Each employee must fill out a W-4 form which will include the information an employer needs for tax purposes:
- Full name
- Current address
- Social Security Number
- Date of Birth
- Start Date
Other important details include:
- Benefits. Always ensure that your employees are offered the benefits for which they are eligible, when they are eligible. To that end, it is critical to keep track of employees’ changing situations and update your records in a timely fashion.
- Bank account information. If you pay your employees using direct deposit, then you’ll need their account and routing numbers in order to run payroll.
Not depositing withheld taxes in a timely manner
Prior to the start of each calendar year, you must determine which of the two IRS deposit schedules you are required to use: either monthly or semi-weekly. If you fail to make a timely deposit, then you may be subject to a penalty of up to 15 percent, depending on how late the deposit is.
In addition, the IRS stipulates that deposits for FUTA Tax (Form 940) “are required for the quarter within which the tax due exceeds $500. The tax must be deposited by the end of the month following the end of the quarter.”
Processing payroll late
Consistently being late with payroll may result in low employee morale and high turnover.
Choose a payroll schedule and stick to it to ensure that employees are always paid on time.
The most common frequencies in the U.S. are weekly, biweekly, semi-monthly and monthly. In determining your schedule, you should also ensure that you are compliant with your state’s pay frequency requirements. Note that you can always pay more frequently but never less.
Taxes are one of the most complicated aspects of payroll management. Common payroll mistakes include:
- Failure to withhold state and federal taxes
- Inaccurate calculation of pre-tax and post-tax deductions
- Failure to include taxable fringe benefits like bonuses
- Excluding reimbursable amounts for travel and other eligible expense
Using manual processes
As you hire more employees, processing payroll manually becomes a time consuming burden, with a higher potential for costly errors. There are many steps involved such as:
- Computing employee hours, voluntary deductions (e.g. 401Ks), incentive payments, sick leave as well as taxes.
- Processing any payroll changes to employee records for new hires and current employees.
- Printing pay stubs, as well as processing and distributing paychecks or direct deposits to all employees on time.
- Verifying and submitting local, state, and federal payroll taxes.
Switching to an automated payroll system will help improve efficiency and accuracy considerably. Employees also benefit because they can easily access compensation information such as deductions and benefits at a glance, allowing for better financial planning.
Many accounting software platforms offer affordable options to help you automate payroll. For example, QuickBooks Online has a free version for up to 10 employees, which can be upgraded for a monthly service fee, for larger teams.
Bonus: Not seeking help as your business grows
Even if you invest in systems to automate payroll, the responsibility still lies with you as the small business owner to ensure that the process is seamless. However, by outsourcing payroll, you can transfer these tasks to a team of experts, freeing up time to focus on your core business. By ensuring accuracy, timeliness and compliance, you can avoid the potential for an IRS tax audit and penalties.
Here at RQB, we can handle all aspects of your payroll (from payroll processing, direct deposit to calculating employees’ work hours). You’ll benefit from access to more technology and expertise to perform payroll well; all while lowering costs and reducing risk.