Top Payroll Mistakes

Here are several common payroll mistakes to be aware of:

1. Misclassifying workers. Misclassifying employees can result in incorrect pay, ultimately leading to overpayment or underpayment of wages. One of the most common misclassification errors is making an incorrect determination about whether an employee should be exempt from overtime. Per the Fair Labor Standards Act (FLSA), all employees must receive overtime pay for any hours worked over 40 hours per week, unless they are classified as exempt. Some states might have more stringent laws about who can be exempt. Make sure you check your state laws. Classifying a non-exempt employee as exempt opens your company to FLSA-related fines.

Another common payroll error happens when an individual is classified as an independent contractor rather than an employee. A misclassification error often results in having to research historical payroll records and make retroactive payments or other adjustments to employee pay. In 2019 alone, the US Wage and Hour Division of the Department of Labor recovered a record $322 million in back pay for misclassified employees. Misclassification not only creates trust issues with your employees, but it is also likely to cost your organization money.

2. Miscalculating overtime pay. It’s illegal not to pay nonexempt employees extra wages for overtime. Nonexempt employees are protected under the FLSA and entitled to overtime pay. According to the Department of Labor, “unless exempt, employees covered by the Act must receive overtime pay for hours worked over 40 in a workweek at a rate not less than time and one-half their regular rates of pay.” 

Paying overtime is not just a matter of paying employees the standard 1.5 times their normal pay rate when they work over 40 hours in a week. Overtime payment errors can arise if you miss a payment in any of the following scenarios:

• When employees work during break times
• When employees spend time traveling between work sites
• When employees are required to participate in activities outside of normal hours, for example, in training, teambuilding, or company parties

Some states have different policies regarding overtime. You should check your state laws to find out if you must follow more stringent rules. Always comply with the law that is more generous for the employee.

If you don’t pay overtime wages to your employee for the pay period those overtime hours were worked, they can file a complaint with the Department of Labor and not only will you have to pay those overtime wages, but you could also face a $1,000 civil penalty (plus any additional penalties brought by the state).

3. Making an incorrect payment to workers. Providing both your employees and contractors with an accurate payroll is the basis of a good professional relationship. Miscalculations with paying your employees or contractors the right amount of money can lead to some serious issues.

Miscalculations waste time, as you’ll need to dedicate hours or even days to investigate and correct errors outside of the regular payroll cycle. 

According to an American Productivity & Quality Center (APQC) study, organizations take between two and ten days to resolve a payroll error. If you underpay your workers by accident you’ll be providing them with less income than they deserved. In the time it takes to fix those errors, employees can grow frustrated or even have trouble paying their bills.

Overpayment is also a serious issue when it comes to miscalculating payroll, which may be due to a simple data entry mistake. However, giving one of your workers more money than they’ve earned is a bad business model. Not to mention that it can seriously damage your company’s finances if it goes unchecked. This is especially true for smaller businesses.

Pay miscalculations can happen with salaried or hourly employees. Common miscalculation scenarios include the following:

• Overpaying or underpaying employees
• Making erroneous retroactive payments
• Missing the first paycheck for new hires
• Paying an employee based on the wrong State
• Deducting the wrong amount for benefits or other payroll deductions
• Improperly paying employees who are on disability or other leaves

Every state has different wage laws and rules and as an employer, your company is required to abide by the laws and rules for the state where your employee works, not the state where your company is based. This rule has become a much larger issue as employers continue to move towards remote work models.

Poor time tracking capabilities can also contribute to miscalculated pay. If your company doesn’t have a reliable way to track employee hours or paid time off, then your chances of making a payroll overpayment or underpayment mistake skyrocket. Relying on paper timesheets makes it easy for employees to log incorrect hours, whether accidentally or on purpose. Data entry mistakes occur when numbers are difficult to read, handwriting is sloppy or paper timesheets are missing or damaged. Even innocent rounding errors cost companies a fortune of extra pay.

4. Not paying nonexempt employees for training or required functions. There are only very rare cases where employers don’t have to compensate their staff for attending a training program. According to the Fair Labor Standards Act (FLSA), training is exempt if it passes all four of these stipulations:

• It takes place outside of normal working hours
• It is not mandatory
• It is not directly related to the job
• No productive work takes place during the meeting, lecture, or training program

If a nonexempt employee is required to go to an office party, he or she must be compensated for that time spent, during or outside of normal office hours.

5. Not properly handling garnishments, levies, or child support. Workers may owe money by way of a court order to other parties. This means whoever is handling payroll will be responsible for deducting these payments from earned wages and sending the payments to the appropriate recipient. Failure to calculate these deductions accurately and remit them timely leaves the company exposed to penalties.

6. Forgetting about a bank holiday. This may seem obvious, but it’s easy to do. When a bank holiday occurs, your workers’ payroll may be late due to the bank being closed unless you process earlier or move your check date to accommodate the holiday.

7. Processing payroll late. You must consistently run payroll using the designated pay frequency for your employees. For example, you might have a weekly, biweekly, semimonthly, or monthly pay period.

Your workers rely on receiving regular wages. Failing to pay them might destroy their trust in you. Employers are required to pay their employees on a certain schedule depending on the state. Paying too late or too infrequently can trigger penalties. And, not running payroll on time can make you noncompliant with state pay frequency requirements.

Run your payrolls with enough time for payments to process. For example, let’s say it takes three days to process direct deposit for payroll. You should run payroll three banking days in advance to ensure that employees get paid on time.

8. Late or inaccurate tax deposits. It is imperative that you report and deposit and payroll taxes to federal, state and local agencies in a timely manner. Deadlines vary based on payroll volume. As your payroll grows, these deadlines become more frequent. Employment taxes are due on a regular schedule. Budgeting for them will ensure that you have the funds available to make your deposits when they’re due (and avoid any late penalties in the process).

Tax rates change regularly. The rates you used when you started paying employees might not be the correct rates now. Make sure you regularly check your employment tax rates. Many tax rates are updated every year.

When you deposit based on the wrong rate, you will have to make up the owed taxes, plus penalties and interest. Late or inaccurate deposits and returns can result in penalties and interest charges. 

9. Miscalculating year-end tax forms or failing to provide them to workers. After a year of processing payments and taxes, organizations must send out all the necessary tax forms to workers.

Employee pay is more than salary, overtime, commissions, or bonuses. In addition to reporting the more traditional forms of employee pay, you also need to report other forms of taxable compensation to the IRS, such as:

• Cost of health insurance provided to owners of S-Corp
• Value of Employer-Provided Group Term Life Insurance
• Employee rewards such as gift cards or travel awards. If the value of a gift equals $75 or more, it needs to be reported as employee income.
• Personal use of a company car

Employees need W-2 forms and independent contractors who receive $600 or more in compensation during a given year must be issued a 1099-NEC form by January 31st of the following year. Often companies fail to produce these forms or neglect to send them out in a timely fashion. In addition, summary returns (Form W-3 and Form 1096 must be filed with the Social Security Administration and IRS respectively).

Depending on how late you are in filing W-2’s, you’ll pay between $50 to $260 in fines for each W-2. Multiply that by only 10 employees, and you’re looking at a tax penalty of between $500 and $2,600.

Many employers also fall into the trap of focusing on their W-2 employees and completely forgetting about their independent contractors. Not sending the 1099 tax forms is one of the most common payroll errors companies make. Failing to issue a 1099-NEC to your contractor can result in hefty penalties between $50-$550 for each missing form. There’s a cap of approximately $3 million in penalties for late forms, though if you disregard reminders to send in a missing form, the cap is lifted completely.

Have all independent contractors complete a Form W-9 at the beginning of their contract. This form will give you all the information you need to file a 1099 form, so you don’t have to worry about tracking down contractors in the middle of tax season.

10. Relying too much on the software program. There are many employers who choose to manage payroll in-house, however the old garbage-in, garbage-out theory still applies. Too many people do not possess the necessary expertise or fail to stay up to date with changes to the law. This is where the experience of a payroll professional is invaluable.

11. Incomplete or disorganized payroll records. An unorganized and inefficient payroll process can be a recipe for disaster. Relying on paper processes, manual data entry, or Excel spreadsheets leads to errors that may take weeks or months to uncover. Disorganized records can also lead you to miss an employee payment or follow-up on items requiring urgent attention.

Relying on an in-house system to manage payroll increases your reliance on one person to manage all payroll actions, making it harder for someone to fill in when the payroll manager is out of the office or leaves the company. 

12. Not keeping your data safe. Whether you're outsourcing your payroll to a third-party service provider or managing it in-house, you need to protect your confidential data from leaking. 

If you've decided to rely on technology, bear in mind that it's not perfect. A server may go down, your computer may get damaged. Keep your payroll information in a secure environment and protected from hackers or any other unauthorized parties. Payroll information should not be disclosed to anyone outside of the payroll department or the senior management team. 

13. Not having adequate backup. Should the individual responsible for payroll be away or sick or leave your employment, the IRS and the state still need to receive payments on time as do employees waiting for paychecks. There needs to be more than one person capable of both understanding and handling the payroll functions. If the computer is “down” for whatever reason, you need to have a backup system for handling all payroll functions. Outsourcing this essential function provides employers with the redundancy required to ensure the payroll function continues to operate uninterrupted.

When they happen, it’s important to deal with any payroll errors immediately. No matter how on top of your payroll game you are, mistakes can happen. But if you notice a payroll mistake, the key is to deal with it immediately. The sooner you recognize and correct any payroll errors, the less likely you are to pay increasing interest and fines. If you can prove it was an administrative oversight (and not an intentional act), you may even be able to get your penalty waived. So, when it comes to payroll errors, the sooner you face and deal with them, the better.