Key points about common payroll errors:
- Payroll errors can be costly and time-consuming to fix.
- Luckily, familiarizing yourself with common mistakes can help you avoid them in your workplace.
- Read on to learn about 6 costly payroll mistakes, how to prevent them, and how to fix them if they happen.
If you process payroll yourself, it can be challenging to keep up with new laws and stay compliant. No matter how careful you are, payroll mistakes can happen. Over time, even small errors can lead to large penalties, fines, and wasted time.
Whether you’re dealing with payroll mistakes right now or just want to avoid them in the future, check out these 6 common payroll errors, their solutions, and the preventative measures you can take to keep your payroll running smoothly.
How common are payroll mistakes?
According to the IRS, nearly 30% of employers make payroll errors each year. That number jumps to 40% for small to mid-sized businesses. The average penalty for an incorrect payroll filing is $845!
6 common payroll errors and their solutions
1. Misclassifying employees as independent contractors (and vice versa)
When you hire someone, you need to classify them as an employee or an independent contractor. This distinction determines whether you tax their wages.
If someone is classified as an employee, you must withhold income taxes and pay Social Security, Medicare, and unemployment taxes on their wages. However, if someone is classified as an independent contractor, you generally do not have to withhold or pay any taxes on their wages.
Unfortunately, 10-30% of employers misclassify employees as independent contractors. If you misclassify an employee as an independent contractor, you may have to pay a large amount of employment back taxes. Employers who intentionally misclassify workers to avoid paying their share of taxes may even face criminal penalties!
How to fix employee misclassification
It can be difficult to determine whether a worker is an employee or an independent contractor. If you think you’ve classified a worker incorrectly, there are a few ways you can handle this payroll mistake:
Option 1 – File Form SS-8. If you are not experiencing an audit right now, you can file this form with the IRS. They’ll help you determine whether a worker is an employee or an independent contractor. If you choose this option, your penalties and tax liabilities may be reduced to one year.
Option 2 – If you are experiencing an audit, you can try the Classification Settlement Program. This program helps you resolve worker classification cases. If you can show that you consistently treated a position as an independent contractor or had a reasonable justification for classifying a worker the way that you did, your tax liability may be limited to one year’s tax assessment. In other words, you would only have to pay one tax year’s worth of back taxes. This can reduce your tax burden significantly.
Option 3 – If you have not been under audit for the past three years, you may be able to use the Voluntary Classification Settlement Program. This program lets you reclassify workers as employees (instead of independent contractors) and receive tax relief in return. If you’re accepted into this program, you would only have to pay 10% of the employment tax liability you owe on wages from the previous tax year. You wouldn’t have to pay any interest or penalties. You also wouldn’t be subject to an audit for previous tax years.
Once you’ve classified the worker correctly, be sure to file the appropriate forms and taxes:
How to avoid worker misclassification
To avoid worker misclassification, make sure you understand the differences between employees and independent contractors. These three categories can help you classify someone:
- Behavioral – In general, a worker is an employee if you have the right to control what the worker does and how they do their job.
- Financial – In general, a worker is an employee if you have the right to control the business aspects of their job (like how they’re paid and whether their expenses are reimbursed).
- Relationship – In general, a worker is an employee if:
- Written contracts describe the relationship between you and the worker as an employer-employee relationship
- The relationship between you and the worker will continue past a specific project or period
- You provide employee benefits like fringe benefits, unemployment insurance, workers’ compensation, and/or health plans
- The worker performs work that’s considered a key aspect of your business
2. Overpaying or underpaying employees
Payroll calculations involve hours worked, paid time off, deductions, and more. Manual data entry and outdated information can make payroll even more complex. With so much data to manage, you might accidentally pay your employees the wrong amount.
How to fix an overpayment
If you overpay an employee, the Fair Labor Standards Act (FLSA) typically allows you to subtract the amount of the overpayment from the employee’s next paycheck. But before you take action, you should communicate with your employee. Let them know:
- How much you overpaid them. They may not have noticed the difference on their last paycheck.
- How you plan to proceed. In most cases, you’ll deduct the overpayment amount from their next paycheck.
- How you can help. Ask the employee if deducting the overpayment from their next paycheck will create any financial hardship. If it will, you can work together to make deductions in stages. If it won’t, you can make the full deduction as planned.
Please note that state requirements may differ from Federal law. To ensure you stay compliant, check with your state for the most updated information.
How to fix an underpayment
If you underpay an employee, follow these steps to fix the error:
- Tell the employee how much you underpaid them. They may not have noticed the difference on their last paycheck.
- Let them know how you plan to proceed. In most instances, you’ll add the amount they were underpaid to their next paycheck.
- Ask them to sign an acknowledgment once you’ve compensated them for the missing wages. Keep this document for your records.
Please note that state requirements may differ from Federal law. To ensure you stay compliant, check with your state for the most updated information.
How to avoid overpaying or underpaying employees
Overpaying or underpaying employees usually results from human error. If you don’t have a fail-safe way to track hours worked, paid time off, and other data, consider investing in automated payroll software.
This type of software helps you identify potentially incorrect paychecks. An all-in-one solution will also update payroll with the correct time worked, PTO, and deductions automatically. This way, your payroll will always be accurate and up-to-date. You won’t have to worry about manual data entry and calculation errors.
If you don’t use software for your payroll processes, you should double-check your employees’ information, hours, and deductions each pay period to avoid mistakes.
3. Miscalculating overtime wages
Whenever a non-exempt employee works more than 40 hours per workweek, you’re required to pay them overtime wages. Under Federal law, you must pay them no less than one and a half times (or 150% of) their regular rate of pay for each hour they work over 40 hours in a workweek.
Different states have additional requirements. For instance, some states require a higher overtime wage rate or have daily overtime requirements, in addition to weekly overtime requirements.
If you don’t pay overtime correctly, you may face penalties and interest. You’ll also owe the employee any missing overtime wages.
How to fix overtime calculations
Overtime-related mistakes can occur for multiple reasons. For example, your overtime calculations may be incorrect if you average hours over multiple workweeks or fail to account for nondiscretionary bonuses.
If you notice the mistake before the employee receives their pay, you may be able to cancel the payroll. You can then issue a new payment with the correct amount to the employee.
However, you may not notice a payroll discrepancy when calculating overtime. If you misclassify an employee and/or don’t pay them overtime as necessary, the Department of Labor will ask you to back pay wages for the time worked but not paid. They may also levy additional fees and penalties.
How to avoid overtime errors
The most effective way to avoid overtime mistakes is by understanding overtime requirements. Be sure you know:
- The difference between exempt and non-exempt and classify your employees correctly
- What types of compensation to include in regular rate of pay calculations for an employee
- State and local overtime laws
In addition, be sure to track employee hours carefully. Time tracking software can make this easier, as it lets employees record their hours more accurately. Some solutions will even alert you when employees are approaching overtime so you know to double-check their hours when processing payroll.
If you don’t have software, make sure you add employee hours correctly each pay period. An overtime policy can help you reduce unnecessary hours.
4. Missing tax deadlines
Payroll involves multiple moving parts, and there are a lot of deadlines to keep track of as a result. If you don’t file your taxes or make the right payments on time, you may face penalties, fees, and interest.
In general, for each month or partial month that your tax return is late, you may be penalized 5% of your unpaid tax amount. For each month or partial month that your tax payment is late, you may be penalized 0.5% of your unpaid tax amount. The penalties will increase depending on how late you file your return or pay your overdue tax amount. The longer you wait, the larger the penalty.
If you’re charged penalties for late tax returns and late payments in the same month, you pay a slightly reduced, combined penalty. Each state may also have its own rules, so check your local legislation.
What to do if you’ve missed a tax deadline
If you realize that you’ve missed a deadline to file or make a payment, gather the materials you need and submit the required information as soon as possible. Even if you don’t have the funds to pay your taxes in full, consider filing your tax return anyway. This way, you won’t have to pay the corresponding penalty for missing tax returns.
After you file, pay what you can toward your taxes. This will reduce additional fees (such as interest).
How to avoid missed deadlines
To ensure you file your returns and pay your taxes on time, check the due dates each year. The IRS’s Online Tax Calendar can be a helpful resource for your business.
Once you’ve checked any relevant due dates, set reminders at least one month before the deadline. This should give you enough time to prepare, but feel free to set earlier reminders as necessary. Creating a checklist of the information you need to file each time can also help streamline this process.
5. Using an incorrect pay frequency
When it comes to employee paydays, deadlines are just as important. Under Federal law, you don’t need to pay employees at a certain frequency (so long as you pay your employees consistently).
However, many states have their own requirements that you need to comply with. Most require you to pay your employees at least weekly, biweekly, semi-monthly, or monthly:
- Weekly – once per week
- Biweekly – once every two weeks
- Semi-monthly – twice per month
- Monthly – once per month
If you don’t pay your employees on time, you may face penalties. Continually making late payments to employees can also affect their employee satisfaction and lead to frustration. In some cases, late paychecks can even cause them financial hardship.
How to correct your pay frequency
If your pay frequency doesn’t match your state’s requirements, you need to change it as soon as possible. To do this, propose a new pay frequency and double-check your state’s legislation to ensure it’s compliant.
Then, notify your employees of the upcoming pay frequency change well in advance. Many employees plan their finances around their paychecks, including expenses for things like rent, utilities, and other necessities. Changing your pay frequency could disrupt their life significantly. You need to give them time to prepare for the change.
Once you’ve implemented the new pay frequency, be sure to adjust employee taxes and other payroll deductions (like benefits and garnishments) to account for the change. The total amount you deduct from an employee’s pay each year won’t change. However, the amount you withhold each pay period may increase or decrease depending on your new pay frequency. For instance, if you switch from a weekly to a biweekly pay frequency, you would withhold a larger amount of taxes each pay period.
How to avoid a pay frequency error
The first step to avoiding this type of error is to comply with your state’s pay frequency requirements (if applicable).
Once you have your pay frequency set (and you’re sure it meets your state’s requirements), it can be helpful to set reminders that notify you when it’s time to process payroll. You may wish to set another reminder for payday.
For example, it may take three days to process payroll. Set one alert to begin processing three days before payroll is due. Set another alert on payday itself to remember to pay employees.
Bank holidays may also disrupt your payroll schedule. Take these holidays into account so your payroll isn’t late.
You can use payroll software to make this process easier. When you change your pay frequency, the software will automatically adjust payroll, taxes, and deductions to match!
6. Not keeping payroll records
The amount of time you need to keep a document depends on the type of document and the information it contains. In general, though, you should keep records of your employment taxes for at least four years after filing the 4th quarter for the year.
Similarly, you need to keep payroll records for at least three years. This includes information like:
- Hours worked
- Pay rates
- Additions to and/or deductions from wages
- Payroll dates
- And more
Each state may have more specific requirements, so be sure to check local laws to ensure you stay compliant.
What to do if you haven’t kept payroll records
It’s important to keep records in case of an audit. If you haven’t been maintaining your records, start now! If you need to access old records and you use HR software, you may be able to pull up those documents in the system.
How to avoid recordkeeping mistakes
To avoid this common payroll error, gather your documents and store them securely. If you use paper documents, consider leveraging an off-site storage facility. These facilities will store your documents safely if you don’t have space in your office.
If you store data electronically, document management or HR software makes it easy to maintain your documents. You can upload and digitize paper documents or create and use digital forms right within the system. In some solutions, you can even archive documents you don’t need on a day-to-day basis. You’ll have them on file if you need them, but they won’t clutter your workspace.
How long does an employer have to fix a payroll error?
The amount of time you have to fix a payroll error generally depends on the type of error and the state in which the employee works. However, experts recommend that you correct payroll mistakes immediately. Don’t wait until the next pay period. If necessary, report the error to the proper Federal and state entities.
How to prevent common payroll errors with automated payroll software
Manual data entry causes 35% of payroll mistakes. When you use payroll software, you reduce the risk of human error. You can also run audits before processing payroll. These audits will flag errors so you can resolve issues before paying employees. As a result, your payroll will be accurate and compliant each pay period.
When you partner with a provider like Sentric, you’ll also be able to work with certified payroll professionals. These experts can help you manage payroll and answer any questions you may have.
If you aren’t quite ready to invest in payroll software, staying informed of the latest payroll laws can help you avoid mistakes. Our Guide for Payroll Professionals eBook covers payroll and tax legislation, wage rates, deductions, contribution limits, tax forms, and more to help you manage payroll accurately.
Common payroll errors infographic
Legal Disclaimer: The information contained in this blog post is for general informational purposes only and is not a list of services that Sentric provides. Under no circumstance shall we have any liability to you for any loss or damage of any kind incurred as a result of the use of the blog post or reliance on any information provided in this blog post. Your use of the blog post and your reliance on any information is solely at your own risk.
