8 Payroll Errors And How To Avoid Them
Payroll is fiddly and there’s no margin for error. Without good payroll management, it’s easy to make mistakes that can result in disgruntled employees, fines and penalties, and reputational damage.
Even when following a stringent checklist for running a successful payroll, errors can slip through.
As Wendy Makinson, HR Manager, Joloda Hydraroll highlights,
“Even with automation and intelligent software, human error is still possible. For example, if a mistake is made at the data entry part of the process the problems can end up being expensive and timely. Information such as classification, hourly rate, payment frequency needs to be triple-checked before submission, etc.”
Here are 8 payroll errors it’s common to see and also how you can avoid them.
8 Most Common Payroll Errors
1. Incorrect employee information
Quite basic but mistakes in employee names, addresses, Social Security numbers, or bank account details can lead to issues with tax reporting, direct deposits, and overall payroll accuracy.
2. Employee misclassification errors
When employers misclassify employees, they fail to correctly determine whether a worker is an employee or an independent contractor.
This distinction is critical because it affects how taxes are withheld and paid, eligibility for overtime and benefits, and compliance with labor laws.
Some common misclassifications to look out for:
- Exempt employees misclassified as non-exempt: Exempt employees are usually salaried and not entitled to overtime pay. Misclassifying an exempt employee as non-exempt can result in unnecessary overtime payments.
- Non-exempt employees misclassified as exempt: This is more problematic, as it leads to non-payment of overtime, violating the Fair Labor Standards Act (FLSA), and resulting in potential lawsuits and penalties.
- Independent contractors misclassified as employees: Businesses sometimes incorrectly treat contractors as employees, leading to unnecessary tax withholdings and benefits.
- Employee misclassified as an independent contractor: More commonly, employees are misclassified as contractors to avoid paying benefits, taxes, and compliance with labor laws. This can lead to significant legal and financial repercussions.
3. Wage calculation mistakes
Errors in calculating wages, overtime, or deductions can result in underpayment or overpayment of employees—neither of which is ideal.
Calculation mistakes in payroll can occur at various stages and for multiple reasons. Here's a detailed breakdown of common calculation mistakes:
- Hourly rate errors
- Hours/days worked errors
- Failure to calculate overtime (remember, things like working through breaks count)
- Incorrect overtime rate or period
- Incorrect tax withholdings
- Incorrect benefits calculations and deductions
- Failing to correctly apply shift differentials
- Currency conversion errors.
4. Not reporting all forms of taxable employee compensation
It’s easy to forget that pay comprises more than salaries, wages, salaries, bonuses, and commissions. Some other forms of compensation that must be reported to the IRS include:
- Fringe benefits: Non-cash benefits, such as company cars, gym memberships, or housing allowances, should be included as taxable income if they do not qualify for specific exemptions.
- Stock options: The value of stock options granted to employees, when exercised, must be reported as taxable income.
- Reimbursed expenses: Reimbursements for personal expenses, if not properly documented as business expenses, should be reported as taxable income.
- Gift cards and prizes: Non-cash awards such as gift cards, prizes, or awards given to employees are taxable and must be reported.
- Severance pay: Payments made to employees upon termination, including severance pay and accrued vacation payouts, should be included in taxable income.
- Tips and gratuities: For employees who receive tips, such as in the hospitality industry, these must be reported and taxed appropriately.
- Allowances: Any allowances provided to employees, such as for meals or travel, should be included in taxable income unless they meet specific non-taxable criteria.
5. Non-compliance with state and local laws
Some states and localities have specific payroll regulations that differ from federal regulations. Here are some common areas where non-compliance with state and local laws can cause issues:
- Minimum wage laws: Many states and localities have minimum wage rates that are higher than the federal minimum wage. Employers must pay the highest applicable rate. Failing to do so can lead to wage claims and penalties.
- Overtime regulations: State laws may have different criteria for overtime eligibility and rates. Some states require overtime pay for hours worked beyond eight in a day, not just 40 in a week. Ignoring these rules can result in underpayment and legal action.
- Paid sick leave: Several states and municipalities mandate paid sick leave for employees. These laws vary in terms of accrual rates, usage, and carryover provisions. Not providing the required sick leave can lead to fines and employee complaints.
- Paid family and medical leave: Some states have their own family and medical leave programs, which may offer benefits beyond those provided by the federal Family and Medical Leave Act (FMLA). Employers must adhere to these programs to avoid penalties.
- Rest and meal breaks: State laws may require specific rest and meal breaks for employees. For example, California requires a 30-minute meal break for every five hours worked and a 10-minute rest break for every four hours worked. Non-compliance can lead to wage claims and penalties.
- Final paychecks: States have different requirements for when final paychecks must be issued after an employee is terminated or resigns. Delays or failures in providing final paychecks can result in fines and penalties.
6. Inaccurate record keeping
Poor or inaccurate record-keeping can lead to discrepancies during audits by tax authorities or labor departments (as well as internal payroll audits) and issues with tax filings.
7. Failure to update payroll systems
Using outdated payroll software that doesn’t account for recent tax law changes or regulatory updates can lead to errors.
8. Missing reporting deadlines
A common error and one that can lead to penalties. Here are some common payroll reports employers must submit, along with their typical submission schedules:
- Form 941 (Employer's Quarterly Federal Tax Return):
- Purpose: Reports federal income tax, Social Security tax, and Medicare tax withheld from employees' paychecks, along with the employer’s portion of Social Security and Medicare taxes.
- Frequency: Quarterly.
- Deadlines: Due by the last day of the month following the end of the quarter (e.g., April 30, July 31, October 31, and January 31).
- Form 940 (Employer's Annual Federal Unemployment Tax Return):
- Purpose: Reports annual Federal Unemployment Tax Act (FUTA) tax.
- Frequency: Annually.
- Deadline: January 31 for the previous year.
- Form W-2 (Wage and Tax Statement):
- Purpose: Provides detailed information on employees' annual wages and the taxes withheld.
- Frequency: Annually.
- Deadlines:
- To Employees: January 31.
- To Social Security Administration (SSA): January 31.
- Form W-3 (Transmittal of Wage and Tax Statements):
- Purpose: Summarizes the total earnings, Social Security wages, Medicare wages, and tax withholdings reported on all W-2 forms.
- Frequency: Annually.
- Deadline: January 31, along with Form W-2.
- Form 1099-MISC/1099-NEC (Miscellaneous Income/Nonemployee Compensation):
- Purpose: Reports payments made to independent contractors and other non-employees.
- Frequency: Annually.
- Deadlines:
- To Recipients: January 31.
- To IRS: January 31 for 1099-NEC; February 28 (paper) or March 31 (electronic) for 1099-MISC.
- State Unemployment Insurance (SUI) Reports:
- Purpose: Reports state unemployment taxes.
- Frequency: Quarterly.
- Deadlines: Vary by state, typically due by the last day of the month following the end of the quarter.
- State and Local Income Tax Withholding Reports:
- Purpose: Reports state and local income taxes withheld from employees' paychecks.
- Frequency: Varies by state and locality (could be monthly, quarterly, or annually).
- Deadlines: Vary by jurisdiction.
- Form 1095-C (Employer-Provided Health Insurance Offer and Coverage):
- Purpose: Reports information about health coverage offered to employees.
- Frequency: Annually.
- Deadlines:
- To Employees: January 31.
- To IRS: February 28 (paper) or March 31 (electronic).
- Form 8027 (Employer's Annual Information Return of Tip Income and Allocated Tips):
- Purpose: Reports tip income received by employees and any allocated tips.
- Frequency: Annually.
- Deadline: February 28.
- Local Payroll Tax Reports:
- Purpose: Reports any local payroll taxes, such as city or county taxes.
- Frequency: Varies by locality.
- Deadlines: Vary by locality.
How To Avoid Payroll Errors And Manage Payroll Better
As you can see, there’s quite a lot to keep track of to successfully manage payroll.
Use these best practices to help avoid errors and ensure an accurate, efficient, and compliant payroll process.
Stay updated on regulations
Regularly update your knowledge of local, state, and federal tax laws and employment regulations. This includes understanding changes in tax rates, minimum wage laws, overtime rules, and benefits regulations. Resources like the US government’s compliance assistance will help here.
Maintain accurate employee records
Keep accurate and up-to-date records of all employees, including their details, tax information, benefits, and any changes in their employment status or pay rate.
The beauty of using technology such as payroll software is that many vendors have an employee self-service portal where they can update their information such as bank account details.
Good systems will also integrate with other applications to decrease manual data entry and ensure accurate records.
Regular audits and reconciliation
Periodically audit your payroll process to ensure accuracy and reconcile payroll records with bank statements and general ledger accounts regularly.
Open communication with managers
Communicate your payroll process with managers reiterating what’s required of them and when.
Clear communication with employees
Maintain open lines of communication regarding payroll policies and changes, provide clear, detailed pay stubs, and be available to answer employee queries about their pay.
Timely and accurate tax filings
Ensure that all payroll-related tax filings are accurate and submitted on time. This includes withholding the correct tax amounts and timely remittance to tax authorities.
Make efficient use of technology
Invest in payroll software that can automate calculations, manage data, and stay updated with the latest tax rates and regulatory changes. To help, here are some key payroll software features.
Use a reliable system for tracking employee hours, especially for hourly workers, and that the system accurately captures regular hours, overtime, and leave.
Prepare for year-end processing early
Start the year-end payroll process well in advance. This includes verifying employee information, updating payroll records, and preparing for tax document distribution.
Seek professional advice
When in doubt, consult with payroll experts or legal advisors, especially for complex issues or major changes in payroll laws and practices. If it’s all a bit too much, there are many payroll companies out there that can manage the process for you.
Document payroll procedures
Maintain a written record of all payroll procedures. This helps maintain consistency and serves as a training tool for new staff.
Plan for contingencies
Have a backup plan for payroll processing in case of emergencies or unexpected disruptions (like technological issues or natural disasters).
Seek employee input
As Malcolm Ferrante, senior accountant at CBS Group, highlights,
“Seeking employee input can also shed light on pain points and highlight opportunities for improvement.”
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