10 Common Payroll Mistakes to Avoid (and what they’ll cost you)

November 6, 2023

Key Takeaways

  • There is much more to payroll than simply ensuring your employees are paid correctly.
  • Proper documentation and withholding practices are essential to the overall financial well-being of your organization.
  • Many organizations outsource payroll to avoid costly mistakes.

Payroll is a critical part of your accounting and reporting – especially during year-end. Proper documentation and withholding practices are essential to the overall financial well-being of your organization. It may sound simple, but there is so much more to payroll than simply ensuring your employees are paid correctly.

When it comes to payroll, there are a lot of things that can easily fall through the cracks and cause major headaches. To help you avoid the time-consuming and costly consequences of payroll issues, we’ve outlined the most common payroll mistakes we see organizations make (and what they’ll cost you).

1. Errors in an Employee’s Legal Name, Social Security Number and/or Address

Do you have an Archie Patrick that goes by Pat? Or a Nancy Jane that goes by Janie? It’s important to make sure you use an employee’s full legal name for reporting purposes. The Social Security Administration sends out no-match letters for W-2s if the name on the W-2 does not match the employee’s Social Security card.

An incorrect Social Security number can cause a misapplication of funds for your Social Security amounts. This results in changes to your W-2 and your state unemployment return. An incorrect address will also cause issues for timely filing of W-2s, especially if you mail them.

Not only will you have to amend your W-2, but you’ll also have to amend all your state unemployment returns. If you don’t move quickly to correct this information, you’ll face a $50 penalty for each time you provide incorrect information.

2. Not Completing All New Hire Paperwork for Your Employees

When a new hire starts, you are required to have them complete specific forms and documents so that you can not only pay them correctly but also report their personal information correctly to both the federal and state agencies. The W4 and I-9 forms are very important and will have all the details needed to report new hire information. It is also hard to contact termed employees when missing information needed for reporting.

If you do not have copies of the new hire forms, you’ll be facing a penalty in the amount of $50 for every W2 form that’s incorrect. In addition, it will cost you valuable time visiting the SSA online portal and submitting the corrected information.

3. Not Understanding the Difference Between an Employee and an Independent Contractor

There’s a big difference between W-2 employees and 1099 contractors. Misclassification of employees results in lost benefits for an individual and can cause the individual to pay higher tax for self-employment.

This is a costly mistake for your company and your employees. Not only will your organization owe back taxes and unemployment taxes, but you’ll also owe any unpaid wages and benefits on top of any state and federal misclassification penalties.

4. Not Having a Plan Document in Place for Pre-Tax Deductions

Pre-tax deductions, like health insurance or health savings accounts, are a great benefit to employees. Pre-tax benefits offer substantial savings for both participants and employers. However, before you offer this benefit (sometimes called a cafeteria plan), you need to have a plan document in place. Reminder that if you are a 2% or greater shareholder of an S Corporation you are not eligible to participate in a pre-tax plan.

Not establishing a documented plan will mean that your entire plan will have to be set up as an after-tax plan, which is not beneficial to either the employer or the employee. Failing to maintain compliance can mean both hefty penalties and a devastating loss of savings to both the participant and the employer.

5. Not Reporting All Taxable Wages on an Employee’s W-2

You should check in with your accounts payable department at least once a year towards year-end. You should be looking for checks wrote out to your employee outside of payroll. Items like cash bonuses, moving allowances or non-business-related expense could be missed taxable wages.

If audited by either federal or state agencies, they could identify this as missed wages and require you to amend past returns/forms and could be costly for both employer and employee on missed tax payments and penalties.

6. Not Monitoring Payroll Software Updates and Limit Changes for Both Federal and State

When using an accounting or payroll software, make sure you’re closely monitoring your software updates. If you’re not, you could see an issue where you over/under-withhold from an employee and over/under pay the taxes.

Not only will you have to take time to amend your payroll returns and W-2 forms, but you will also have to explain the error to your employees. You may also face additional penalties.

7. Not Reporting the Correct State on Your Employees’ W-2

If you have an employee who has either moved from one state to another and/or an employee who travels for work in multiple states, you will be required to understand the state requirements for where the employee is performing services in.

Employees may become upset if they are filing their personal tax returns and they realize that there is incorrect information on their W2. This could also require amending the W2 form and the state returns that are affected by this mistake.

8. Applying Tax Payments to the Wrong Quarter

Your check date determines what quarter your tax payment is applied to. If you misapply this payment, you will receive letters from the IRS that show over- or underpayments depending on how the payment was misapplied.

It depends on how long the payments have been misapplied, but correcting this error will almost certainly cost you a significant amount of paperwork and time.

Take Pennington County as an example. It underwent an IRS examination, resulting in substantial penalties ($87,140.63) for mishandling payroll taxes, despite officials believing they were doing it correctly. The issue arose from employees receiving 24 paychecks per year in advance, which should have been treated as semi-monthly payroll, causing taxes to be paid late. The IRS is strict about one-time payroll tax payments, with penalties ranging from 2% to 15% for payments made late. To avoid penalties, ensure you pay your withholding tax on time.

9. Incorrect Time Reporting for Your Employees

It is important to have a time and attendance system to correctly document your employees’ hours for both worked time and non-worked time. Time systems can help account for proper rules on reporting overtime during an employers established work week. They are also good to help employees request time off and track their paid time off.

This mistake can put your companies name into the paper letting everyone know that you did not report overtime correctly and the amount of back wages that you had to pay out to your employees. This is a costly mistake when you under pay your employees and will also lose your employees trust in your company.

10. Not Reconciling Your Payroll Returns to the W-3

Your federal and state forms should always match your W-3 taxable wages and tax withholdings. If this does not happen, you will receive notices to either fix the returns or the W-2s.

Correcting this error involves completing paperwork for both Federal and State agencies, which can be incredibly time-consuming.

Payroll is Critical to Your Accounting Operations

Failing to maintain proper payroll procedures can be time-consuming and costly. The good news is, by taking a more strategic approach to payroll, you can avoid costly mistakes and ensure your payroll is completed timely and accurately.

Some organizations choose to do payroll completely in-house, while others find outsourcing works best. Either way, it is critical that you ensure your organization is up to date on ever-changing regulations and timely with reporting requirements.

The Eide Bailly payroll team has vast expertise in accounting and payroll ensuring you are accurately documenting and reporting on payroll taxes and preparing the necessary forms. Rest assured that your organization will never miss a payroll and the process will be done correctly.

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