10 Payroll Mistakes Your Small Business Must Avoid

10 Payroll Mistakes to Avoid

Engaging employees allows your company to function and grow. But doing so puts employer responsibilities on your shoulders. Running afoul of these responsibilities can trigger penalties, and failing to take advantage of opportunities can cost you taxes, both of which can hurt your bottom line. Here are 10 payroll mistakes to avoid.

Payroll Mistakes to Avoid

Giving Comp Time

When your non-exempt employees (generally hourly workers) work more than 40 hours in a workweek, you owe them time and a half. You can’t sidestep this obligation by giving them comp time (allowing them to take off the overtime hours worked). Doing so violates the federal Fair Labor Standards Act (FLSA).

Classifying Workers Improperly

If workers are your employees, you owe payroll taxes on their wages and taxable benefits. You can’t avoid these taxes by labeling workers as independent contractors if they truly are employees. Doing so can result in serious tax penalties as well as penalties from other federal and state agencies.  Check IRS guidance on worker classification.

Delaying Last Paycheck

When you terminate a worker or he or she quits, you owe a final payment. While federal law doesn’t require that you pay the worker immediately, state law may. Review the rules in your state. Violating these rules can result in penalties or even legal action.

Reimbursing Travel and Entertainment Under a Non-accountable Plan

If you reimburse employees for the cost of traveling or entertaining on company business, you may be incurring needless employment taxes if you don’t arrange the reimbursement properly. If they simply ask for reimbursement and you pay it, the reimbursement is taxable to them and subject to payroll taxes. If, however, you adopt an “accountable plan,” the reimbursement isn’t taxable to them and you don’t owe payroll taxes; you deduct the T&E expenses. To be an accountable plan, you need to follow IRS guidelines.

Paying Creditors Before the Government

If you’re experiencing a cash crunch, be sure to put the IRS at the top of your list. If you choose to pay the landlord or other creditors instead of first paying payroll taxes, you can become personally liable for all of these outstanding taxes, even if your business is incorporated or a limited liability company. Make payroll taxes a priority so you don’t trigger a trust fund recovery penalty.

Handing Off Payroll Obligations

While some small businesses do payroll in-house, others choose to let outsiders — accountants, bookkeepers, payroll companies, and professional employer organizations (PEOs) — handle the work of figuring withholding, depositing taxes and filing payroll tax returns. Usually, this works out well, but there are some bad payroll people who fail to meet their obligations, and you get into trouble. Why? Because as the employer you’re responsible for all of these payroll obligations. It’s up to you to monitor their activities on your behalf. The IRS has a listing of certified PEOs, which are companies that meet IRS-set standards. The listing is updated periodically.

Ignoring Unemployment Claims

When a worker leaves the company, he or she may apply for unemployment compensation. If the departure is voluntary, or the worker was terminated for serious misconduct (e.g., sexual harassment of a co-worker, being intoxicated on the job, stealing from the company), he or she isn’t entitled to unemployment compensation. If you fail to challenge erroneous claims, you may needlessly be paying higher state unemployment tax. Check with your state about how to challenge a worker’s erroneous claim for benefits.

Being a Bad Record Keeper

The law requires you to maintain payroll records and make them available to the IRS under certain circumstances. Usually, you must keep records for at least four years. These records include time sheets or other records of hours worked, expense accounts, copies of W-2s and I-9s, accident reports, and any other relevant payroll information.

Failing to Have New Employees Complete Form 8850

You cannot tell by looking at a new employee whether he or she is from a targeted group that would entitle you to claim the work opportunity credit. Have each new worker complete Form 8850, an IRS form. It is used to pre-screen workers for purposes of the credit. The form must be submitted to your state employment security agency (SESA) no later than the 28th calendar day after the date the member of a targeted group begins working for you. If you don’t, you can’t take the work opportunity credit even if you’d otherwise be entitled to it.

Missing Employment Posters

You are required to display posters for certain federal and state employment laws. If you fail to do so, you can be penalized. The amount depends on the type of poster that’s required to be displayed. Find the federal posters you need from the DOL’s Poster Advisor. Your state labor department can tell you which state law posters to use. Don’t pay an outside company for them. Download required posters from government websites.

Payroll Statement Photo via Shutterstock

Barbara Weltman Barbara Weltman is the Tax Columnist for Small Business Trends. She is an attorney and author of J.K. Lasser’s Small Business Taxes and The Complete Idiot’s Guide to Starting a Home-Based Business. She is also the publisher of Idea of the Day® and monthly e-newsletter Big Ideas for Small Business® and is a trusted professional advocate for small businesses and entrepreneurs.