How Small Business Owners Can Avoid These 5 Common Payroll Errors

Payroll Analysis

Few operations within your business are as sensitive or prone to mistakes as payroll. This isn’t surprising considering the amount of time, organization and concentration that payroll demands.

Because payroll is governed by so many regulations and requires close attention to detail, you may have accepted that errors are simply unavoidable. While you may not be able to guarantee flawless payroll execution every single time, there are steps you can take to reduce the chance of mistakes.

The first step is to be aware of the most common payroll errors that businesses make. These are:

  1. Misclassifying workers
  2. Incorrect deductions and withholdings
  3. Poor timekeeping practices
  4. Miscalculating overtime wages
  5. Missing payroll deadlines

We’ve identified effective strategies to help you improve your payroll procedures and avoid these five mistakes so you can keep your employees happy and avoid costly penalties.

1. Misclassifying Workers

The IRS takes employee classification seriously since misclassification can cause businesses to pay less in taxes. Misclassification can also lead to noncompliance with the Fair Labor Standards Act. This act sets the minimum wage and governs overtime pay and recordkeeping.

There are four main classifications of workers: employee, contractor, exempt and nonexempt. It’s essential that you correctly classify your workers to ensure their taxes and benefits are accurate and that you’re paying the right amount of employment taxes.

Worker classifications defined

Employee: The IRS defines an employee as someone who performs services for you where you control the details of how the work is done. For example, you can mandate that an employee work from your office from 8 a.m. to 5 p.m. Monday through Friday.

Employees are entitled to a minimum wage and overtime pay, and employers are responsible for deducting taxes from their paychecks. Employers also pay an equal portion of these taxes as part of their employment taxes.

Contractor: An independent contractor is a self-employed individual who is not eligible for overtime and is responsible for their own employment taxes. They have complete autonomy over how, when and from where they do the assigned work.

For example, a contractor cannot be required to work from your office or keep specific hours. When you hire a contractor, you identify the end product you want, and they create this deliverable in whatever manner they see fit.

Exempt: Exempt employees are those who do not qualify for overtime pay. This most often applies to professional positions that are compensated by a salary rather than per hour. However, a salary does not automatically make an employee exempt. They must also perform exempt job duties such as supervising employees.

Nonexempt: Nonexempt employees are entitled to overtime pay for working more than 40 hours in a workweek. Nonexempt employees are often paid hourly. With some exceptions, workers who earn less than $23,600 per year are nonexempt.

For more details on worker classifications, click the links below:

2. Incorrect Payroll Deductions and Withholdings

Deductions and withholdings are amounts subtracted from an employee’s paycheck. Incorrectly calculating these amounts is a common payroll issue because there’s no standard formula you can apply to every employee. Instead, you have to consider details such as income bracket, filing status and number of dependents for each person.

What’s the difference between withholdings and deductions?

Withholdings refer to money that is taken from an employee’s pay to cover social security, Medicare, income and state taxes. Withholdings are required by law to be taken from every employee’s paycheck.

Deductions are most often contributions that an employee voluntarily agrees to make. Common deductions include retirement contributions or premiums to cover employer-sponsored health plans. In some instances, an employee may be subject to involuntary deductions such as wage garnishment for child support. Deductions are more complex than withholdings because you must know which deductions are taken pre-tax and which are post-tax.

How to avoid inaccurate payroll withholdings and deductions

The tips below will help you avoid the frustration of miscalculating deductions and withholdings for your employees.

Have W-4 forms for each worker. To calculate withholdings and deductions correctly, you’ll need each employee’s adjusted gross pay for the payroll period and a W-4 form (also called an employee withholding certificate). Ensure every employee completes a W-4 form upon hiring. This form records the employee’s name, address, filing status and dependent claims.

Know the FICA tax rates. FICA taxes refer to social security and Medicare taxes. The social security tax rate is 7.65%, and the Medicare rate is 1.45%. You’ll deduct this percentage from the employee’s gross wages for the pay period. Don’t forget that employers are required to pay employment taxes. To do this, you’ll match the amount each employee pays for their FICA taxes.

Avoid calculating federal income taxes manually. Determining income tax requires using tax tables that many people find overwhelming, often leading to payroll mistakes. To help with this, the IRS created a free income tax withholding spreadsheet to help employers correctly calculate how much income tax to withhold from employees’ paychecks.

Determine gross pay correctly. For hourly employees, multiply their hourly rate by the number of hours they worked during the pay period. For salaried employees, divide their total annual salary by the number of pay periods in the current year.

Remember that social security is capped. Employers often withhold too much social security tax from high-earning employees. The maximum taxable income for 2021 is $142,800. The Social Security Administration sets the amount each year based on cost-of-living adjustments.

Know which deductions are pre-tax and which are post-tax.

Pre-tax deductions:

  • Health insurance
  • Retirement plans
  • Health savings accounts
  • Short-term disability
  • Long-term disability
  • Flexible spending accounts

Post-tax deductions:

  • Roth 401(k) contributions
  • Some life insurance policies
  • Employer-sponsored pension plans
  • 529 college savings plans
  • Union dues
  • Wage garnishments


3. Poor Timekeeping Practices

Employee timekeeping can be a source of endless headaches for employers. No matter how well thought out your timekeeping policy is, employees will inevitably turn their timesheets in late, forget to clock in or out, lose their timecard or work unauthorized overtime.

It’s still essential that you have a smart method for tracking employee time and a comprehensive policy to guide it, but know that you will have a few blips that you’ll need to address every pay period.

Embrace technology for better payroll timekeeping

Most employers today find that timekeeping software is more effective than traditional manual methods. Time tracking technology is a flexible solution that can work for any employee, whether they work on-site or remotely.

Payroll is much less stressful if you catch issues early. Time-tracking software can help you identify issues before you’ve calculated your payroll. With a tech solution, you can receive notifications when problems arise. You can set up alerts for when an employee is nearing overtime hours or when they clock in but forget to clock out.

Timekeeping tips for more accurate payroll

  • Federal law dictates that you must pay employees for all rest breaks under 20 minutes, and this time counts toward overtime hours.
  • Meal breaks that are 30 minutes or longer can be unpaid in almost all circumstances as long as the employee does not have to do any work during that time.
  • If your timekeeping software automatically clocks employees out for lunch, it’s important to make sure that your employees are truly relieved of all duties during this time. If an employee has to work through any portion of their meal break and it isn’t paid, you’re at risk for lawsuits from employees and fines from the Department of Labor.
  • Check with your state labor office to identify any state-specific requirements for employee time tracking.

4. Miscalculating overtime wages

Any nonexempt employee is entitled to overtime pay. Most employees are hyper-aware of every minute of overtime they’ve earned, so it’s imperative that you accurately calculate their overtime pay. Making mistakes in this area will erode the trust you have with your employees. It also puts you at risk for penalties and may require you to pay a large lump sum of overtime back wages.

Tips for accurate overtime wage calculations

  • The rate for overtime pay is 1.5 times an employee’s normal rate (sometimes called “time and a half”) and is applied to all hours worked in a week beyond 40. The Fair Labor Standards Act sets this rate.
  • Many states have supplemental laws about overtime, so it’s important to seek out overtime rules for your area.
  • If an employee earns a commission, this must be added to their normal hourly rate when calculating overtime wages. This applies to any commission they earned during the week they worked over 40 hours.

5. Missing deadlines

Payroll is not something you postpone, no matter how busy you get. Paying employees on time is a vital component of reducing turnover and maintaining office morale. Even tax deadlines have more flexibility than payday deadlines. The IRS might grant you an extension, but you can be sure we guarantee employees won’t.

The first step in ensuring you meet payroll deadlines is to understand your payroll schedule. Most companies operate using one of four common schedules:

  • Weekly: Employees are paid each week on a specific day of the week.
  • Bi-weekly: Employees are paid every other week on a specific day of the week.
  • Semi-monthly: Employees are paid twice a month on specific dates, such as the 15th and 30th.
  • Monthly: Employees are paid once a month on a set date.

Once you know your payroll schedule, create a calendar that marks each payday for the year and the timeframe it covers. Consider sharing a copy of the payroll schedule with employees so everyone understands when they can expect to be paid and what days each check will cover.

Next, assign a timesheet due date for each pay period. This is the due date by which employees must have their timesheets approved and turned in so you can calculate everyone’s pay. It’s helpful to send out reminders to employees about when timesheets are due, as people often get busy with work and personal responsibilities and may forget.

It’s very important to understand that you’re legally responsible for paying employees on time for the correct number of hours worked, even if they neglect to turn in their timesheets. If you don’t receive an employee’s timesheet, work with them or their manager to determine the number of hours worked as accurately as you can. If it turns out the pay was incorrect, make adjustments as soon as possible.

Is it worth it to do payroll yourself?

There are many factors that determine whether it’s better to outsource payroll or do it in-house. Do you (or does someone on your team) have experience with payroll and human resources? If you’re well versed in payroll, you are in an excellent position to complete payroll yourself. Knowledge and experience make all the difference.

If you are new to doing payroll, you may find it’s more cost-effective (not to mention less stressful) to outsource this service. A company that understands the ins and outs of payroll can ensure that you stay compliant with the IRS, FLSA and Department of Labor. Penalties such as fines and paying back wages can quickly derail your company’s finances and create a work environment full of unhappy, distrustful employees.

To decide whether outsourcing payroll is the right choice for your business, objectively evaluate your level of payroll expertise. The more experienced you are, the fewer headaches and risks you’ll face. If you know this area is not your forte, it’s more financially responsible to outsource the service to ensure everything is done correctly.

If you need help determining whether you should outsource your payroll, contact BES today. We’re family-owned and operated, and our team is happy to help you evaluate the best payroll option for your growing business.