8 Payroll Mistakes to Avoid . . . and Some Fixes

8 Payroll Mistakes to Avoid . . . and Some Fixes

One company failed to pay its workers’ compensation insurance and was faced with a $96,000 penalty.

Another company incorrectly classified an employee as an independent contractor and had to pay back taxes and incurred substantial penalties.

And yet another company struggled to understand company registration rules in various states.

These are all common payroll mistakes we’ve either heard about or or assisted in fixing in recent years. As today’s workplace continues to evolve amid a prolonged and unpredictable pandemic backdrop, companies need to be mindful of avoiding costly payroll mistakes.

Here at Juna, we’ve compiled a list of common payroll mistakes to avoid and offer up some of our best practices (we call it “the fix”) for dealing with challenges. Since maintaining an accurate and efficient payroll really goes to the heart of business operations, it is imperative to clear up any problems before things get too thorny—and costly.

The List: Payroll Mistakes and Their Fixes

1. 1. 1. 1. Misclassifying Employees (Part I): Confusion over employees vs. independent contractors is a common mistake.

We bristle whenever we hear someone say “1099 employee.” There’s no such thing. At the most basic level, individuals are either employees who have taxes withheld and receive a W-2 each year, or they’re independent contractors who receive a 1099 from the company. Still, there are many misconceptions about who is a “W-2” and who is a “1099.” For example, just because someone works part time doesn’t mean that person can be classified as a contractor. Here are some other common myths posted by the Department of Labor (DOL).  Both federal and state authorities have been cracking down on misclassified employees recently and the penalties are substantial – they can easily double the amount that was originally paid to the individual. In addition to IRS and state penalties, there are criminal penalties imposed by the DOL that can include up to one year in prison per misclassified employee. That’s definitely a mistake to avoid.

The fix: The DOL posted this general guide and resources to help you determine the status of a worker. If you have any questions, consult with an HR advisor or an attorney, preferably one who is familiar with employment law. We also recommend written agreements with workers to document the determination of independent contractor status and ensure that they understand they’re responsible for all taxes.

1. 1. 1. 2. Misclassifying Employees (Part II) Failing to understand overtime rules, i.e. “exempt” vs. “non-exempt” classification –  According to 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. Again, the fines for violating the FLSA can be substantial.

The fix: Make sure you understand the laws, and consult with an HR expert or attorney to help you make the determination. Here are some Department of Labor (DOL) resources regarding overtime pay.

1. 1. 1. 3. Out of state woes (Part I): Hiring out-of-state employees – This is, by far, the hottest issue that companies are dealing with today. While hiring out-of-state employees allows you to widen your talent pool, it can get complicated quickly. Each state has its own employment laws that companies must comply with. And we have direct experience that some states—namely New York and Washington—have particularly stringent registration and reporting requirements, while California has strict employment laws. 

The fix: First and foremost, make sure the employee in question is worth the extra effort. Then, make sure you understand all of the requirements including: overtime and PTO requirements, paid family leave, disability, and workers’ comp insurance. (The case of the $96,000 workers’ comp fine referenced above was for one employee in NY.) Alternately, many companies are dealing with this by hiring professional employer organizations (PEOs) which provide small businesses with HR management, benefits administration, and payroll processing support. PEOs are expensive, but they mitigate risk, which may be worthwhile. PEOs also provide other HR services and make sure they’re in compliance there. We advise our clients on a case-by-case basis.

1. 1. 1. 4. Out of state woes (Part II): Failing to register your company – Many companies don’t realize that they need to register as an employer when they hire outside their home state. Registering as an employer in another state places the company on the tax authority’s radar and may require the company to pay income tax in the state of hire. 

The fix: Again, tax laws vary by state so make sure you understand the registration, reporting, and tax requirements before you make an offer. Check with your tax professional about how it may affect your tax liability and ensure you are filing properly.

1. 1. 1. 5. Failing to leverage your payroll provider – Companies need to be mindful of their employment tax liability when dealing with payroll providers. There are lots of solid providers — including ADP and Gusto — who are there to make things as streamlined as possible for your company. But things can go awry if you don’t structure your business relationship properly.

The fix: When selecting a payroll provider, make sure the employment taxes will be automatically submitted. In other words, instead of paying the net amount to your employees and submitting the withholding taxes to the government, use a payroll company that takes the full gross amount from the company, pays the net to the employee and submits the employment taxes directly on your behalf. This shifts the responsibility to the payroll company to pay them on time.

1. 1. 1. 6. Incorrectly using QuickBooks for payroll – We’ve seen it all too often: Companies decide to do it themselves and use QuickBooks Payroll. Before becoming our client, one company used QuickBooks Payroll and missed the deadline to submit their employment taxes. The penalty: $25,000. Ouch. 

The fix: If you’re using QuickBooks Payroll, ensure that you understand employment laws and don’t miss deadlines. Better yet, QuickBooks Payroll has a version that will pay the employment taxes on your behalf, and payroll companies like Gusto and ADP will also make sure you’re complying with state laws including workers’ comp insurance (which you can even buy directly through Gusto).

1. 1. 1. 7. Not properly reimbursing employees for expenses. The IRS requires employers to have what’s called an “Accountable Plan,” as this article in the Journal of Accountancy explains. In a nutshell, if employers don’t require their employees to substantiate expense reimbursements with receipts, the reimbursements could be classified as income to the employee and be subject to income taxes and employment taxes for both the employee and employer plus interest and penalties, which can be substantial.  

The fix: Implement a policy that requires employees to submit receipts and substantiation of business purpose for all expenses to be reimbursed. At Juna, we use Expensify to facilitate the expense reporting process for our clients and their employees.

1. 1. 1. 8. Changing payroll providers mid-year. Switching mid-year causes additional administrative requirements because the historical pay must be reported to the new payroll company so they have the proper year-to-date amounts for calculating employment taxes and ensuring that the W-2s are correct.

The fix: Find out which payroll provider will submit quarterly and annual filings including W-2s. Better yet, wait until year end to switch providers.

By being aware of these common mistakes, you can aim to avoid them in the first place. This will reduce hours of wasted time and potential fines and will pave the way for a smoother payroll process.

If you need any help with payroll or accounting, reach out for a free consultation at info@junafinancial.com.