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Even if you’re regularly paying employees, you may not be aware of the consequences of payroll errors should they arise. Mishaps can impact nearly every area of your business, including staffing, finance, and even legal considerations. However, by understanding what’s at stake, you can take the necessary steps to avoid many common payroll errors, and keep your business running smoothly.
Key takeaways about the consequences of payroll errors
- Payroll errors can have significant consequences
- Your ability to attract and keep talent can be impacted
- Employee productivity drops when frequent payroll errors are made
- Payroll errors can impact your company finances
Having said that, the majority of problems can be prevented, particularly if employers are aware of what they are. In this guide, we’ll cover some of the most common repercussions that can come with payroll errors, why employers need to understand them, and some general guidance on how to avoid them.
What are the risks associated with payroll?
Of all the tasks that small business owners must complete, one of the riskiest is payroll. While a typo in other areas may be easily corrected, a payroll mistake or miscalculation can have serious consequences — for both businesses and their employees.
Inattention to detail can result in:
- Paying terminated employees
- Data entry errors when entering employee hours
- Missed or making the wrong deductions
- Incorrect classification of workers
Now that we have an idea of what’s at risk, let’s find out more about the top ripple effects.
For employers, what are the most common consequences of payroll errors?
From unwanted attention from Uncle Sam to productive employees potentially looking for jobs elsewhere, mistakes can impact your business in more ways than you may expect. Let’s review some.
Employee-related consequences
Payroll errors can negatively impact your employees in any number of ways. Here are just a few examples.
Employee dissatisfaction
After working all week, employees expect and depend on being paid for their efforts. When a paycheck is late or inaccurate, employees begin to lose their trust, which can lead to other consequences.
Lower employee morale
Morale plays an important role in keeping your employees happy and productive. When paychecks are continually wrong, employee morale drops considerably. This directly impacts business operations, making it difficult to recover. Low morale is also contagious — just one unhappy employee can directly impact an entire department.
Reduced productivity
When employee morale drops, expect productivity to follow. If employees have to deal with frequent payroll errors, especially if they pride themselves on doing a good job and completing tasks on time, they will have little incentive to continue to do so.
Increased employee turnover
Every employee expects to be paid accurately and on time. When this doesn’t happen, employees often begin looking for a job elsewhere. It’s estimated that it only takes one or two flawed paychecks to give employees the incentive to look for other employment.
Losing top talent
You spend a lot of time and effort recruiting the best talent. Do you really want to lose them because of a slipup that could have been avoided? All the perks and promises made to top talent may prove to be irrelevant if their paychecks are riddled with errors. Constant payroll mistakes make employees feel unappreciated and more likely to take their skills and experience elsewhere.
Financial and legal consequences
Not only can payroll errors increase employee turnover, these errors often have financial and legal consequences for your employees and your company.
Employees receiving incorrect wages
A Market Watch study found that more than 66% of surveyed employees are living paycheck to paycheck. So, when payday comes around, mishaps are the last thing anyone is worried about. We would all love to have a nest egg to fall back on, but with two-thirds of Americans relying on their next check to pay the bills, even one payroll error can cause significant hardships.
Financial losses for employees
A late check, overtime hours not paid, or even an overpayment can cause issues for employees. For instance, if an employee needs their paycheck to pay their rent, mortgage, or other bills, they can suffer serious financial losses with late fees and even eviction notices. Additional repercussions include increased interest rates, and even a ding to their credit score. As a result, dissatisfied employees will begin to look for another position.
Tax trouble
Employees aren’t the only ones that can suffer financial losses resulting from payroll errors. In 2023, the IRS recovered around $10 billion dollars in civil penalties assessed for payroll taxes, which amounts to $10 billion in late fees, penalties, and back payments. Remember, a payroll error isn’t just a shortfall for your employees — it also impacts the amount of payroll taxes that you pay.
Legal issues can arise
Legal issues are another consequence of payroll errors. The IRS, state, and local tax authorities can assess penalties for tax underpayments or erroneous amounts paid, usually the result of payroll errors. But along with tax issues, payroll errors can also result in employee lawsuits for back pay, short pay, or nonpayment.
Organizational Impact
The consequences of payroll errors extend beyond your employees and can have a direct impact on your business.
Damaged reputation
A company’s reputation is one of its most valuable assets. Unfortunately, if your business has constant turnover and dissatisfied employees, your reputation will likely suffer. This can directly impact your ability to increase revenue and attract top talent. It’s also very difficult to change people’s perception of your company once its reputation has been damaged.
Negative impact on company culture
A major part of your company culture is based on how you treat your employees. If you’re known as a fair employer that treats their employees well, people will want to work for you. However, payroll errors can directly impact your company culture, driving away potential employees. This can prompt those already working for you to look for a job elsewhere — and share their experience with colleagues before they do.
Loss of employee trust
Trust is always a two-way street. If you want to be able to trust your employees, your employees should be able to trust you as well. If employees frequently receive incorrect paychecks, this could raise doubts — even if foul play has nothing to do with it. Individuals may feel operations are unorganized and give them pause about staying with your company for the long-term.
How long does a company have to fix a payroll error?
Simply put, employers should take immediate action to correct any payroll mistakes they discover, with the issue being rectified by the next pay period. There are no federal laws governing how quickly employers must take corrective action. If the payroll mistake includes an employee underpayment or is owed a back payment, they can file a complaint with the US Department of Labor Wage and Hour Division.
Furthermore, many states such as Wisconsin and New York, make it simple for employees to dispute wages if they feel something is amiss. To be sure that you’re abiding by state regulations, check with the department of labor in the state(s) where you pay your employees to see if there is a set time for issuing back payments.
How to avoid issues altogether
We spoke with David Kindness, a certified public accountant (CPA) with over a decade of experience helping small business owners. He shares some guidance on how to keep these issues at bay in the first place. Here’s a checklist that David says can help you stay ahead of making mistakes.
- Create a payroll policy — and stick to it
- Evaluate your current payroll provider to be sure that they are keeping up with state and federal regulations
- Develop a payroll calendar and checklist for weekly and monthly activities
- Automate and integrate payroll as much as possible
- Audit your payroll processes once or twice a year
— David Kindness, CPA
When running your business, consider the consequences of payroll errors
It makes sense to treat payroll with the same level of importance as other areas of your business. Error-ridden payroll carries significant consequences for your business, including increased employee turnover, tax penalties, decreased productivity, and even potential lawsuits — all which can negatively impact your company’s reputation. By managing payroll with basic best practices you can mitigate potential risks, keep employees happy, and give yourself peace of mind.
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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.