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Avoiding common payroll mistakes

Payroll can be one of the more challenging responsibilities for a small business owner. Even a simple mistake can create frustration for employees and take time and money to correct. Errors involving tax withholding, deposits, or reporting can also lead to interest and penalties.

And while payroll software or an outside payroll provider can make the process easier, they don’t eliminate the need for oversight. Your business generally remains responsible for making sure payroll is handled correctly and taxes and reports are submitted on time.

Here are some steps that can help reduce the risk of common payroll mistakes.

Withhold and deposit payroll taxes properly

Employers generally must withhold federal income tax and employees’ share of Social Security and Medicare taxes from their wages. Employers are also generally responsible for paying the employer’s share of Social Security and Medicare taxes.

These amounts must be deposited with the IRS and reported on the appropriate payroll tax returns. Additional rules may apply to the 0.9% Additional Medicare Tax, federal unemployment tax, and state and local taxes.

One common source of payroll errors is entering information incorrectly from an employee’s Form W-4, “Employee’s Withholding Certificate.” Changes to an employee’s name, address, or visa status can also affect payroll information and may create additional issues if they aren’t handled correctly.

Pay attention to tax deposit deadlines

One of the more serious payroll mistakes is failing to deposit federal income tax, Social Security and Medicare taxes, and the employer’s share of Social Security and Medicare taxes on time.

IRS penalties can increase the longer a deposit remains unpaid:

• 1 to 5 calendar days late: 2% of the unpaid deposit
• 6 to 15 calendar days late: 5% of the unpaid deposit
• More than 15 calendar days late: 10% of the unpaid deposit

The penalty may increase to 15% if more than 10 calendar days pass after the date of the first IRS notice or letter. A 15% penalty may also apply on the day a notice or letter demanding immediate payment is received.

There is an even more serious consequence if the IRS determines that the failure to deposit withheld taxes was willful. A 100% penalty may apply, and the penalty can potentially be assessed personally against individuals who are responsible for collecting and paying those taxes.

Put procedures in place

To help reduce the risk of payroll tax errors, establish procedures for reviewing employee withholding information and tracking tax deposit deadlines.

Even if you use an outside payroll provider, your business generally remains responsible for making sure federal taxes are deposited and paid and payroll tax returns are filed on time. It’s a good idea to regularly compare your payroll records with the amounts reported and deposited and investigate any discrepancies promptly.

Remember that taxable compensation includes more than wages

Salaries and wages aren’t the only forms of compensation that may be taxable to employees. Bonuses, awards, and certain fringe benefits may also need to be included in an employee’s taxable income.

If these amounts aren’t properly included in payroll, you may not withhold enough in taxes. This can lead to payroll tax penalties and may also result in incorrect information on employees’ Forms W-2, “Wage and Tax Statement.”

Before processing a bonus, award, or fringe benefit through payroll, review how it should be treated for tax purposes. This is particularly important when introducing a new employee benefit or changing a compensation arrangement.

Keep in mind that the rules for federal income tax withholding, Social Security, and Medicare taxes aren’t always the same. The tax treatment of a particular benefit may depend on the circumstances.

Correct payroll mistakes promptly

Even with good procedures in place, payroll mistakes can happen. When you discover an error, start by determining:

• What went wrong
• Which employees and payroll periods are affected
• Whether the issue involves taxable wages, withholding, tax deposits, or information reporting

Once you understand the problem, you can determine what needs to be corrected. Acting promptly is important because the available correction procedures may depend on when the mistake was discovered.

Depending on the situation, you may need to:

• Adjust an employee’s pay
• Correct your payroll records
• Make an additional tax deposit
• Correct a previously filed employment tax return

For example, certain errors reported on Form 941, “Employer’s Quarterly Federal Tax Return,” may need to be corrected using Form 941-X, “Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund.” An incorrect Form W-2 may require Form W-2c, “Corrected Wage and Tax Statement.”

Keep records explaining what went wrong and the steps you took to correct it. If the error affects an employee’s pay or tax information, communicate with the employee promptly so they understand what happened and whether they need to take any action.

Keep your payroll on track

Payroll mistakes can be costly, but having clear review procedures can help reduce the likelihood of errors. When mistakes do happen, addressing them quickly may help limit the potential consequences.

If you discover a payroll error or have questions about your payroll tax responsibilities, contact your local Padgett office. We can help you understand the applicable rules and review your payroll practices to help keep your business in compliance.

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