Payroll errors can happen. Though anyone can make a mistake (we’re all humans, after all), by putting some operational redundancies in place, there are ways to keep mistakes to a minimum. By putting some operational redundancies in place, you’ll likely be able to avoid mishaps when paying employees and create a reliable system that reduces risks.
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Key takeaways about payroll errors
- Payroll errors can lead to decreased employee morale, unnecessary business costs, and compliance issues with tax authorities
- Common payroll mistakes include missing deadlines, misclassifying employees, failing to keep up with changing laws, and incorrectly handling overtime and retroactive payments
- Preventing inaccuracies involves developing clear policies, regularly auditing processes, automating systems, and staying informed about relevant state and federal regulations
In this roundup for business owners, we will discuss some of the most common payroll errors, how employers can set up processes to avoid them, and what to do if you do have to deal with them on occasion.
What do payroll errors cost a business?
May affect morale
Making mistakes when running payroll can affect businesses in different ways. There’s the possibility of upsetting — and chipping away at the confidence — of reliable employees, which could erode trust in your leadership and lead them to start considering other employment options. An OnPay small business survey found that roughly 40% of small business owners consider hiring the right people to be a difference-maker (and 60% of small business owners are personally involved with the new hire process).
The takeaway is that employees may not have much patience with payroll oversights — in some cases, moving on after two mistakes with their paychecks. Companies spend a lot of time looking for top talent, and the idea of losing them because of a process that should have been buttoned up from the beginning can be frustrating.
Out-of-pocket costs
You may also end up spending money where you don’t need to. For example, you may experience something called payroll leakage. In many cases, this is due to outdated payroll processing techniques, leading to tasks falling through the cracks, which can end up costing you money that could otherwise be used to complete projects and fuel your business. The consulting firm Deloitte has conducted studies that have found payroll leakage can cost employers up to 2.5% of their total payroll costs.
Compliance considerations
Mishaps affect more than just a pay stub. Having employees also comes with specific tax obligations, such as paying FUTA taxes to help fund unemployment insurance (typically owed to the IRS on a quarterly basis), and making sure FICA taxes (which consists of both Social Security and Medicare taxes) are also taken care of.
— David Kindness, CPA
You’ll want to be sure these deductions are set up properly from the outset so that these taxes are paid correctly, on time, and to the right agencies so you can avoid compliance-related issues with the tax man.
Now that we have an idea of how payroll mistakes can impact an organization, let’s detail some of the potential slip-ups that should be on your radar.
What are some of the most common payroll errors?
Though every company is going to be different, there are some usual suspects when it comes to mishaps when processing payroll. Here are some of the most common.
Missing deadlines
Almost all businesses are responsible for managing the payroll taxes they owe, which must be reported and deposited with federal and state agencies on specific dates throughout the year. Payroll errors can complicate the process of making sure these are processed accurately and on the right dates.
For example, are you an employer that withholds more than $1,000 in Social Security, Medicare, and federal income taxes from your employee’s wages? Remember that you’ll need to fill out and submit Form 941 (also known as the Employer’s Quarterly Federal Tax Return), which is due by the last day of the month following the end of each quarter. We have more details on deadlines here.
Missing deadlines (whether intentionally or not) can result in avoidable penalties and interest charges from Uncle Sam. It can be helpful to mark important dates on a calendar and have a reliable system in place to manage payroll and make your payments. Most reliable payroll software does this for business owners automatically, and software can even automate significant portions of the payroll calculation and submission process, making your life even easier. This is important to keep in mind if you are learning how to do payroll yourself.
Late payments
Paying employees late undermines trust and can even cause anxiety for those who rely on timely paychecks to manage their personal finances. A report from the Department of Economics at MIT touched on how employees can experience a dip in productivity when under stress about their personal finances. In some cases, late payments can also lead to potential fines. For instance, the state of Pennsylvania has rules in place should an employer forgo delivering wages to workers within 30 days of a scheduled payday (with fines that can cost up to $500).
Overtime rules
Violating overtime rules is a common payroll error that some employers end up being guilty of. Simply put, under the Fair Labor Standards Act (FLSA), non-exempt employees must receive overtime pay for hours they have worked over 40 hours in a workweek. If the individual crosses this threshold, they must be compensated at a rate not less than time and one-half their regular rates of pay.
What can happen is that businesses make the mistake of misclassifying employees as exempt or go without a system to accurately track the amount of time an employee works. This can make it tricky to know who should receive overpay when calculating wages. Many businesses will use a time-tracking system that is synced to their pay runs, so all the calculations happen automatically. It can also be a good idea to clearly communicate overtime policies to employees, discuss any shift differentials you may offer, and add a section to your company handbook.
Misclassifying employees
This happens when an employer lists an employee as an independent contractor or vice versa. This can lead to trouble with the IRS and the Department of Labor (DOL) because taxes and employment laws are different for each classification. And each is supposed to receive a different form by January 31 each year.
Pro tip
If you need to update a classification with the IRS (or are unsure what the classification should be), you can complete and submit Form SS-8.
And by the way, if the person working for you thinks they are being classified incorrectly, they have the ability to share this information with the federal government as well. The point is that understanding the rules and having a consensus with your team members can go a long way towards building trust and not attracting unwanted attention.
Not keeping up with changing laws
Minimum wage and employment tax laws can (and typically do) change over time. For example, California recently put legislation in place that increased minimum wage rates for fast-food workers only — and it happened four months into the year. It can be a good idea to keep up with legislation in the state or city where you do business and make sure you have the tools (or payroll specialist) in place who can pivot when changes occur.
Tax issues related to employee classification
Misclassifying employees as independent contractors is a common error that can lead to significant legal and tax problems. This mistake can result in:
- Paying employees who were incorrectly classified as contractors back pay, medical, retirement, paid leave, and any other regular employee benefits that they did not receive while being classified as a contractor.
- Worker’s compensation: If an employee is misclassified as an independent contractor and they get hurt while on the job, they won’t be covered by insurance, and employers could be liable for their medical bills and lost wages.
- Unemployment insurance: Employees misclassified as independent contractors won’t have unemployment insurance withheld from their paycheck. If they get laid off, the employer could be legally responsible for making up these payments.
- Underpayment of payroll taxes, which can result in significant tax penalties
- Penalties and back taxes if this issue is discovered during an audit
- Legal issues with the Department of Labor (DOL)
Avoid mistakes
OnPay is perfect for that small business owner who wants to avoid payroll mistakes, pay employees on time, and take care of quarterly reporting with ease. It’s been the best investment for my business!
— Shelley Medeiros, Owner, Shelley Medeiros Agency
Failing to keep records
Federal agencies require payroll records to be kept for a certain period of time. Specifically, the IRS says that employers should keep employment tax records for at least four years. This is especially important should a business ever be subject to an IRS audit. Organizing payroll records can sometimes be an afterthought when there are so many other to-dos on a business owner’s plate.
That said, there are many ways to keep files safe, secure, and accessible — both digitally and physically. For instance, you use a cloud-based storage system to organize and retrieve documents. Other companies stay with tried-and-true methods like a sturdy, lockable filing cabinet in the office. We have a separate article on maintaining payroll records with guidance on the documents you need to keep track of (and tips from professionals in the payroll field).
Making retroactive payments incorrectly
Retroactive payments, or “retro pay,” are made when an employee is owed additional wages from a previous pay period. While these payments are sometimes necessary, errors in calculating or processing them can lead to further complications. If you identify an error, you’ll want to avoid making another mistake when addressing the issue you already need to take care of (which could put you further down the rabbit hole).
Common mishaps for retro pay include:
- Forgotten or delayed pay raises
- Miscalculated overtime
- Mistakes in calculating bonuses
- Overlooked shift differentials
- Errors in commission calculations
- Not updating for their state’s minimum wage increases
- Retroactive court-ordered payments due to employment law issues
Not reporting garnishments
Other oversights include neglecting to report court-ordered wage garnishments, making manual errors while filing them, and missing deadlines. These errors can occur when employers intentionally or unintentionally ignore court-ordered garnishments, resulting in fines and legal action. Similarly, because garnishment orders specify the maximum percentage of an employee’s income that can be withheld, calculating garnishments incorrectly can harm the employee and could result in legal and regulatory issues. Finally, garnishment orders typically specify a start and end date for withholding, and employers must adhere to this timeline as well as withholding and reporting garnishments by the deadlines specified in the order.
Not reporting new hires
In almost every state plus the District of Columbia, new employees must be reported to the state government where you do business. So as new hires are being brought onboard, they’ll have to complete a W-4 form to calculate the proper tax withholding each pay period, as well as having them fill out an I-9 form. That said, states typically have a web-based “new hire reporting center” to help employers complete these tasks. For example, here’s one for Georgia and one for Illinois.
Most payroll service providers will do this for business owners. For example, OnPay reports this information for clients each Friday. But if you are not already working with a payroll software provider, then this is a task you’ll need to add to your to-do list each time a new worker joins your team.
Failing to report all taxable forms of compensation
Almost all forms of income are taxable unless they’re specifically called out for exemption by law. For example, compensation in the form of fringe benefits or bonuses employees receive is usually subject to taxation and must be reported correctly for tax purposes. The mishap here is that employers may not entirely understand all that needs to be taxed (and what can be ignored).
Overlooking these can end up having an impact on tax forms as the year comes to a close. What exactly are we referring to? Taxable fringe benefits, like standard employee wages, must be reported on an employee’s W-2 form. So knowing the difference between taxable and nontaxable forms of income can prevent a flood of filing mistakes — and turn what should be a positive development (rewarding your employees with perks) into a headache.
Avoiding errors in payroll management
Develop a payroll policy that everyone can understand
Having a clear payroll policy can help prevent misunderstandings. A policy should spell out the type of pay period you use, the types of pay you utilize (regular pay, overtime, fringe benefits, bonuses, commissions, etc), any required deductions (and why employees may see differences in their gross and net pay), and who on your team is responsible for taking care of errors that come up. Everyone involved in payroll processing should understand and follow these guidelines at all times.
Evaluate your current payroll provider and processes
Review your payroll provider and processes regularly to ensure they meet your business’s current needs. Sometimes, switching providers or updating processes can significantly reduce errors and time spent on managing and processing payroll.
Automate and integrate payroll processes
Automation minimizes human error and helps ensure timely calculations and payments. Integrating payroll processes with other business systems can streamline your operations and ensure consistency.
Develop a payroll calendar and checklist for weekly and monthly activities
A detailed payroll calendar and checklist can help you stay organized and ensure you don’t miss critical deadlines or payroll tasks. Regular monitoring and updates can prevent last-minute scrambles and mistakes.
Payroll audits are a good idea
Though you likely won’t need to add this to your calendar each week, it can be a good idea to schedule a payroll audit at least once or twice a year. This can help you look for any gaps in operations, see if schedules are being overbooked, and ensure that the books are in order.
How to fix payroll mistakes (If they happen)
Despite your organization’s best efforts, payroll mishaps can still happen. If an issue arises, instead of hitting the panic button, it’s likely that whatever occurred can be taken care of before it gets too out of hand. Here’s how payroll issues should be handled:
- First, uncover any issues: having a process in place to double-check for payroll errors or to allow employees to notify you of issues can help manage payroll mistakes quickly and efficiently. Allowing employees to take part in the process will help them trust you and feel empowered to speak for themselves.
- Next, address the issue immediately: Promptly correcting errors shows your commitment to accuracy and employee satisfaction.
- Then, communicate with affected employees: Transparency is key. Inform employees of the mistake and the steps being taken to resolve it. Let them know that you have their best interest at heart and will do your best to avoid similar mistakes moving forward.
- Finally, adjust future payrolls: Correct any issues with your current payroll process. If the error you identified could happen again in subsequent payroll runs, then update your process accordingly to ensure ongoing accuracy. Additionally, educate all members of your team who are involved in the payroll process.
Payroll errors can be avoided with a dash of expertise
Avoiding payroll mistakes saves time and money, and keeps employee disputes to a minimum. Errors can prevent a company from staying compliant, lead to a decline in employee productivity, and even end up affecting a company’s bottom line. Though not a task you need to complete every day, it’s a good practice to review your payroll operations throughout the year to safeguard your business and provide peace of mind to your employees.
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Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.