How to Avoid Common Payroll Mistakes in Your Small Business

Author: Rupert Jones

Rupert Jones

Rupert Jones

8 min. read

Updated October 25, 2023

Payroll is one of the least appreciated yet most essential functions in a business. 

When done well, payroll can help your organization stay safe from legal consequences and keep your employees content. However, when done incorrectly, payroll mistakes gain momentum, ripple across the company, and can become costly to fix, both in time spent and money lost.

As a positive, most common payroll mistakes are easy to navigate, fixable, or avoidable with proper planning. To avoid these 10 common payroll errors, like misclassifying employees and miscalculating pay, let’s examine why correcting these mistakes are so important. 

Why you should implement the following payroll corrections

All businesses that have employees must do payroll, but that can mean something different for each company. For example, payroll can refer to:

  • The employees you pay, which also includes employee information.
  • The amount paid to employees each pay period.
  • The process of calculating and distributing taxes and wages.

In a payroll program, an employer must follow the payroll laws of the state they inhabit. For example, under California law, the minimum wage must be $14.00 per hour for workers at businesses with more than 26 employees and $13.00 per hour for companies with 25 or fewer.

Employee satisfaction 

An employer who pays an employee the incorrect amount is late on issuing payments or deducts taxes incorrectly will frustrate and worry the employee. An unsatisfied employee will constantly wonder whether or not their paycheck will be on time or even in the correct amount.

During tax time, an employee will have to pay out of pocket for miscalculated taxes, and the employer must do the same with added penalties. Dissatisfied employees won’t work hard to impress you, leave your start-up in droves and write bad reviews for your company.

Penalties and jail time

If an employer paid a worker the $13.00 per hour wage when they have over 26 employees, the employer could face fines or even jail time. In addition, employees would have a right to sue the employer, which could cost them their livelihood, reputation, and personal finances. 

Willful violators of wage theft, which is the denial of wages rightfully owed to the employee, comes with fines up to $10,000 from a first conviction and imprisonment after future convictions. It’s common for a judge to rule wage theft as “willful” because ignorance of the law is rarely usable in court as a reason to violate the law.

For these two reasons, it’s necessary for all small businesses to adhere to Federal payroll laws as well as State-Specific Tax Laws, or you could face severe consequences.

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How to avoid these 10 common payroll errors in your start-up

With a process as complicated as payroll, there are numerous places an organization can make fatal errors. Let’s look at the 10 payroll mistakes your company should tackle immediately.

1. Misclassifying workers as independent contractors

The Fair Labor Standards Act provides protections and benefits, like minimum wage and overtime pay, for employees (W-2 form). An independent contractor (1099) doesn’t receive these protections, as employers who hire them don’t pay a portion of their taxes.

Misclassifying workers as independent contractors rather than employees reduces labor costs (up to 30 percent for some businesses) but is unfair to both employees and other companies and can lead to a hefty fine. Not only will employees lose important wages and benefits, but it means the government loses valuable tax dollars, eventually resulting in over or underpayment.

2. Incorrectly identifying workers as exempt or non-exempt

Exempt employees are not entitled to overtime and are expected to finish their job, no matter how long it takes, without extra pay. These workers are exempt if they perform specific (relatively high-level) job duties, are paid on a salary basis, and earn at least $23,660 per year. 

If a non-exempt employee is treated as an exempt employee, they miss out on overtime or an hourly wage, which will result in wage theft. Therefore, unless an employee agrees to be paid a salary (which is typical for high-ranking positions), most non-exempt employees should be paid hourly.

3. Not paying the correct amount of overtime

If workers are non-exempt, they need to be paid time and a half for any hours worked above 40 per week. Some states have additional rules, e.g., in California, workers must be paid overtime for working more than eight hours in a workday, even if they don’t exceed 40 hours per week.

Non-exempt salaried employees may also be entitled to overtime unless they are exempt from overtime under the State Labor Code or if an enforced or existing order (like welfare or child support) regulates the employee’s hours, wages, or working conditions. Employers can use a clock-in/time management system to ensure they’re accurately maintaining employee hours.

4. Choosing the wrong payroll service provider

It’s essential to choose a payroll service provider that will suit your company’s needs. This may mean switching providers as your company grows. When choosing a payroll company, ensure that they can provide high-quality payroll services, like the following:

  • Payroll Processing: Automates payrolls most labor-intensive aspects, like tax withholding, calculations, and payment options, such as digital or paper checks.
  • Calculate, Withhold and Pay Taxes: Removes errors in calculating and paying taxes, including the most expensive and common mistakes, like overtime.
  • Compliance: Delegates the right forms to the right employees, like the W-2, 941, 1099, and W-9. Payroll service providers will ensure this info is accurate and up-to-date.
  • New-Hire Reporting: Deadlines are tight for new hires, especially for calculating enforced or existing orders. Reports will be filed with the proper agency and on time. 
  • PTO-Management: Keeps track of employees’ paid time off, including parental and medical leave, vacation time, sick days, and personal days without hassle.

Employees should have access to these services through a mobile app, so they can see a discrepancy immediately and act on it in time for their next paycheck. 

5. Not keeping payroll records for long enough

It’s common for start-ups or new businesses to throw out or incorrectly file payroll, making them difficult to track down. However, doing so could put your business at risk of paying fines on correctly calculated payroll simply for not keeping records long enough to show proof.

Payroll records should be held for at least three years, and many experts recommend keeping them for four years. It’s preferred to keep records longer than the law-stated minimum because the IRS may find a discrepancy later down the line. At any time, the IRS could notice a payroll error, and it’s up to the business to show proof. Otherwise, the company could receive a fine.

6. Having only one person trained on the payroll software

At any time, your staff could become ill and miss important tax dates or paycheck filing. It’s essential to have a backup person (or people) who can competently run payroll if the usual person is out sick and unable to do it. Having a backup plan will ensure a business stays legally compliant, and the staff won’t foster resentment from a missed or miscalculated paycheck. 

7. Not maintaining confidentiality

All payroll information shouldn’t be disclosed beyond the payroll department and senior management team. This means records must be handled carefully – e.g., payroll information shouldn’t be left on a printer (or left visible on a computer monitor) in a general area of the office. Having documents in plain view can affect your reputation with clients and employees.

Instead, keep your payroll documents in a locked cabinet or a password-protected/encrypted file that only required personnel can access to ensure confidentiality amongst staff. Remote employees can use password-protected encrypted files or software that supports Advanced Encryption Standard (AES), as AES offers a high level of security and optimization.

8. Overpaying or underpaying employees

A simple data entry mistake could lead to an employee being overpaid or underpaid. If an employee is underpaid, this means an expensive bill when the underpayment is discovered, and you need to repay them. If an employee is overpaid, it can be tricky (and cause a lot of upset) to get your money back. It’s best to double and triple-check your work to avoid this situation.

9. Missing a tax deadline

Payroll taxes need to be paid before specific deadlines, and missing these can result in hefty late charges or penalties. Therefore, it’s important to be aware of deadlines and initiate your tax payments well ahead of the due date. You’ll have to file income tax returns on the following dates:

  1. April 15: Default deadline for calendar year-end for corporations.
  2. June 15: Default deadline for calendar year-end for foreign corporations.
  3. October 15: Extended deadline from April 15 deadline.
  4. December 15: Extended deadline from June 15 deadline.

Depending on your circumstances, you may need extra time to file, or you’ll need to file more regularly if your business income exceeds a specific amount. Research your Federal and State laws before filling your documents for the IRS, or you could face fees despite filing on time. 

10. Paying your employees late

Paying your employees late is a considerable payroll mistake because it could open you up to potential lawsuits and worry your employees. It could cause them real financial hardship – and it could also send the message that your company is in a poor financial situation, leading to employees fearing layoffs. Never leave your employees in a situation that causes fear.

To ensure your employees are paid on time, use a to-do list or other software that delegates tasks, like Asana, to keep your payroll team on track. Alternatively, you can use a hands-free approach that automates payments or transfers paychecks to an employee’s bank account

Keep your employees happy and stay legally compliant 

Staying on top of payroll and the issues surrounding payroll is really important. Get this wrong, and your business could face serious consequences. The last thing you want is a lawsuit on your hands or disgruntled employees that are worried about their jobs. So, take action today by avoiding the 10 common payroll mistakes, so you can successfully scale your business.

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Content Author: Rupert Jones

Rupert Jones is a financial independence geek who strongly believes in the power of networking. He spends his time helping people leverage secrets of financial wealth and processes to achieve financial freedom.