5 Common Payroll Mistakes & How to Correct Them
Maintaining a payroll system can be delicate and complex, which means that sometimes mistakes may happen. In fact, errors are more common than not, so if you’re a business owner, you’ll have to be diligent in ensuring no payroll mistakes are made or missed. You’ll also have to be diligent in ensuring your business is compliant with federal and state labor and tax laws. Even one mistake could cost your business thousands of dollars or cause complete ruin. Some errors are difficult to catch, but you can better guard against them by learning what the most common payroll mistakes are and how they can be fixed or avoided.
Misclassifying Employees as Independent Contractors
Classifying an employee as an independent contractor can be a costly payroll mistake, because when the worker is reclassified you’ll have to handle backup withholdings, pay employment taxes and pay interest penalties and fines. Additionally, if you can’t provide proper reasons for misclassifying an employee, then you may owe a lot of money to the Internal Revenue Service (IRS) according to the Internal Revenue Code section 3509.
The only way to fix this error is to reclassify any misclassified workers and pay the penalties for this violation unless you have proper reasons for the classification. However, since most companies can’t afford to pay these penalties, it’s probably best that you work hard to avoid this mistake. The best way to do this is to keep a close eye on worker classification, use a payroll system that automatically updates you when any employee’s status with your company changes and by understanding the difference between an employee and independent contractor.
Neglecting to Issue 1099 Forms to Vendors
Independent contractors aren’t the only ones who must receive 1099 forms from a business. All other vendors must be issued 1099 as well. Failing to issue these forms in a timely manner can result in penalties. Penalties range from $30 to $100 per missed form with a maximum of $500,000 per year. The amount of your penalty will depend on how long it takes you to issue the forms once the issuing deadline has passed.
Additionally, if you don’t provide the correct payee statement, then you may be subject to a penalty of $250 per statment – no maximium amount for this penalty. You can avoid this mistake by issuing 1099 to vendors before the deadlines. These deadlines are:
Miscalculating Your State Unemployment Tax
- Contractors Only: January 31 for Nonemployee Compensation and form 1099-Misc
- All Vendors: February 28 for paper filings
- All Vendors: March 31 for electronic filings
Failing to pay or miscalculating your state unemployment tax can cause you to lose your federal unemployment tax credit. Plus, businesses in Pennsylvania, New Jersey and Alaska have employee and employer paid tax that must be calculated. This means that if your business is in one of these states, you must take extra care when calculating your unemployment taxes. To avoid miscalculating this tax, you should find out what the correct maximum wage amount is in your state. Calculating your state unemployment tax involves merely multiplying your state tax rate by the wages you pay each employee.
Failing to Subject Vendor Payments to Backup Withholding
If you own a business, then most likely you use vendors to help you run that business. These vendors will need to be paid for their service, but you must be careful about how these payments are remitted. Because, these payments can be subject to backup withholding at a rate of 28 percent.
Before paying any vendor, you must obtain a W-9 form. The IRS will definitely audit you without the use of this form, but in some cases they may conduct an audit with the use of this form. In case of an audit, the IRS will be seeking to collect a penalty on the amount that should’ve been withheld from the vendor payment. However, you can avoid an audit and/or penalty by knowing what types of payments are subject to backup withholding. The types of payments subject to withholding are:
Failing to Keep Good Records and Practice Good Bookkeeping
- Interest Income or interest that’s reportable on Form 1099-INT
- Qualified check that’s reportable on Form 1099-PATR, Taxable or patronage dividends paid in cash
- Non-employee compensation, rents and commissions, reportable gross proceeds paid to attorneys, royalties, and other determinable or fixed income payment, gains, profits or other income payments reportable on Form 1099-MISC
- Original Issue Discount if paid in cash or original issue discount that’s reportable on Form 1099-OID
- Dividends that are reportable on Form 1099-DIV and Distributions received from cooperatives
- Gross payments that are reportable on Form 1099-K
- Proceeds From Broker and Barter Exchange or gross proceeds that are reportable on Form 1099-B.
- Gambling winnings that are reportable on Form W-2G
Payroll records must be maintained meticulously, especially in case of an audit. Businesses are required to keep payroll records from the past three years and even longer in some states depending on state labor laws. Keeping good records includes holding on to W-4s, I-9s, payroll files (pay stubs, tax forms, etc), W-2s and other employee tax forms and time sheets.
Besides maintaining good records, your business should also implement good bookkeeping practices. Payroll must be integrated into the books, because the books directly impact your cash flow. Good bookkeeping will help keep you aware of how much money you have available and how much you can invest in your employees and business. Using a bookkeeper, accountant or accounting software will help you keep good records and practice good bookkeeping.
There are more payroll mistakes to be concerned about, but these are some common ones that can be avoided and/or simply fixed. All you have to do is pay close attention to your payroll process and be ready act when any discrepancy is found. This will save you a lot of money and time or even save your business entirely.