Accurate payroll processing is essential for companies to ensure compliance with tax laws and labor regulations and maintain employee satisfaction.
Even a minor error in payroll could lead to severe issues, such as legal penalties, fines, higher scrutiny from authorities, and frustration among employees. In fact, the IRS conducted a survey in 2021 that showed that over 33% of employers make payroll errors every year, resulting in hefty fines and compensations.[1]
In this post, I’ll walk you through the most common payroll errors, how to avoid them, how they can affect your business, and the best practices to follow for payroll management.
7 Most Common Payroll Errors
Payroll is one of the important functions of any business that ensures employees are paid on time and accurately.
Errors in payrolls can lead to serious penalties, dissatisfaction and mistrust among employees, and financial losses. Therefore, it is essential to calculate the payroll accurately to avoid these risks. Below are some of the common payroll errors in organizations.
1. Misclassifying Employees
Misclassifying employees is the most common payroll mistake companies make, largely due to confusion. According to a Remote survey, over 53% of employees have faced payroll issues during their careers.[2]
Many businesses treat independent contractors as full-time employees and provide employee benefits, health benefits, overtime pay, and more. If that’s the case with you, you may face legal and tax issues, as well as unnecessary documentation and financial losses.
If you refer to the Fair Labor Standards Act (FLSA), employees must receive overtime pay if they work over 40 hours per week, unless the company mentions them as exempt. However, classifying non-exempt employees as exempt makes your company pay FLSA-related fines. Doing so is also unfair, as non-exempt employees miss out on their overtime earnings.
For example, a digital marketing agency hires freelancers for a project. Instead of classifying them as independent contractors, the company mistakenly considers them full-time employees.
They receive employee benefits and are also exempted from paying taxes. During audits, the company could face many troubles and may have to pay additional taxes or bear penalties because of employee misclassification errors.
2. Incorrect Tax Withholdings
Tax withholding plays an essential role in payroll as it corrects the amount of local, state, and federal taxes deducted from your employees’ paychecks. Errors occur when companies fail to update employees’ tax forms according to the local laws, change details in tax brackets, or apply incorrect tax rates.
Incorrect tax withholdings affect employees’ finances. They also expose businesses to penalties and regulatory scrutiny.
For example, a mid-sized company has four branches worldwide, and all must adhere to different state tax rules. The company transferred one of its IT teams to another branch for operations but miscalculated their tax withholdings. Employees get overtaxed, which leads to frustration during the refund season.
3. Missing Deadlines
Every employee depends on consistent paydays. Even a single delay in payday could make a huge difference in an employee’s life, finances, and mental well-being. This is how missing payroll and tax deadlines become an issue for employees and companies.
There are many reasons a company may miss the payroll and tax deadline, such as focusing on other business priorities, missing payroll information, processing payrolls inefficiently, entering data manually, tracking time slowly, and miscommunication among payroll stakeholders.
These errors affect employees and companies as you need to pay waiting time penalties every day for missing payments.
For example, a small business firm forgot to file its payroll taxes due to scheduling errors. Because of this, the IRS imposes late payment penalties and charges interest on the missing tax amount.
4. Failure to Track Overtime Accurately
As per FLSA, if an employee works more than 40 hours in a workweek, it’s counted as overtime. This rule is valid only for non-exempt employees. Calculating and tracking overtime accurately is difficult as overtime laws vary depending on the state and country.
While calculating overtime income factors like commissions, tips, shift differentials, and bonuses is important, it’s a challenge for the company. If some employees fail to punch in and out correctly, it results in miscalculations.
Errors occur when a company fails to consider scenarios, such as employees working during break times, traveling to work sites, or participating in activities outside of regular hours, such as company parties, training, or company meetings.
For example, a large restaurant fails to calculate and track the overtime work of its employees during peak hours or the holiday season. They pay salaries as per the standard rates and expect to adjust with increased demand. Once it gets into court, the company is bound to pay back the extra wages, fines, and legal fees.
5. Incorrect Benefit Deductions
Employee benefits, such as retirement plans, commuter allowances, health insurance, unemployment insurance, job-protected leave, etc., must be accurate while deducting. Errors in deductions can lead to overpayment, underpayment, or financial confusion for your employees.
Experienced professionals could also make mistakes while deducting benefits due to varying eligibility rules, manual communication with carriers, and changes to the annual benefit plan.
Suppose a manufacturing company introduced a new employee insurance scheme but failed to update the payroll systems. As a result, a group of employees get incorrect tax deductions from their paychecks. The HR professionals then have to manually correct the deductions, causing late payments and employee dissatisfaction.
6. Incomplete or Disorganized Records
While maintaining and organizing payroll records for legal requirements, companies may make mistakes, affecting their payrolls directly.
It is crucial to organize and manage records accurately for efficient payroll management. A single missing record can lead to errors in payroll processing and audits, making it difficult to comply with regulations.
For example, a construction company suddenly faces an IRS audit. Failing to provide proper records, including tax documentation and employee timesheets, and the IRS-imposed fines could damage the company’s financial stability and reputation.
7. Failure to Report All Taxable Employee Compensation
Many companies provide non-monetary benefits, such as gift cards, bonuses, travel allowances, and more. Some don’t know that these non-monetary benefits are taxable and need to be reported in payroll reporting.
If you don’t recognize non-monetary benefits, you may face compliance issues during the tax period.
For example, a retail agency rewarded its top performers with holiday vouchers worth $1,000 to each high-performing employee but failed to report the vouchers as taxable income. During the audit, the agency was penalized for not reporting the complete employee compensation.
How to Avoid Common Payroll Errors
Businesses risk losing money, time, and employee trust due to payroll errors. You’ll need a proactive approach to avoid errors like missed payments, data entry mistakes, incorrect tax fillings, and failure to report all employee compensation. Below are some points that help you minimize payroll mistakes.
1. Use Reliable Payroll Software
Payroll software helps reduce errors in payroll and save thousands of dollars in penalties. Large companies often use advanced payroll solutions to automate complicated calculations and comply with tax compliance and state regulations. The tool provides detailed reporting and insights, so you will know all calculations.
Recent years have seen an increase in payroll software adoption as well. A survey by PayrollOrg shows that 62% of companies now employ agile cloud payroll technologies to handle their payroll management and processing.[3]
So, choose a reliable payroll software solution to reduce manual errors, simplify the tax calculation process, and save time.
While selecting payroll software, look for important features, such as integration with time-tracking systems, automatic tax updates as per the latest tax laws, and customizable options for employee benefits.
I’d recommend payroll software like Deel or Rippling, if they fit your budget and requirements.
2. Regularly Audit Payroll
To avoid scrutiny from the IRS, perform regular audits to identify discrepancies and maintain accuracy in tax calculations. Periodic audits enable you to solve issues like missing tax deductions, outdated employee records, incorrect overtime calculations, and more.
Compare payroll data with attendance records and time sheets, review tax filings, validate bank account details, and review benefit contributions to conduct an effective audit. Regular and effective payroll audit ensures compliance and reduces the chances of errors.
3. Stay Updated on Tax and Labor Laws
Tax and labor laws are constantly changing. If you don’t comply with these laws and regulations, it can lead to legal complications and penalties. So, stay updated with changing laws and regulations.
Subscribe to newsletters from labor departments or tax authorities and attend webinars on payroll regulations. Additionally, partner with a tax consultant or advisor to clarify complex tax requirements.
This helps you adapt to the changes and enables your company to follow payroll practices thoroughly with current state laws. It also avoids payroll errors that can impact your business.
4. Provide Ongoing Training for Payroll Staff
Your payroll staff is responsible for managing payroll and its accuracy. A lack of knowledge and skills or updating themselves with evolving tax regulations may introduce errors in your payroll.
Provide proper training to enhance their skills and knowledge, and equip them with modern payroll systems. Ensure you include best practices for using payroll software, techniques for double-checking before paychecks and tax payments, and understanding tax law requirements in your training programs.
These programs will boost confidence, keep your team up-to-date, and reduce payroll errors.
5. Maintain Open Communication with Employees
Open or transparent communication between the company management and employees promotes trust and reduces future disputes. Encourage your employees to verify their pay slips and immediately report to the HR department for any discrepancies.
Ask your employees to update their bank and personal information regularly to avoid tax issues. Provide a clear channel for them to understand the benefits and deductions in their paychecks.
When you resolve their tax-related issues quickly, their trust in your company increases, and the chances of conflicts reduce.
6. Ensure Accurate Employee Data Collection
Accurate payroll is only possible if you have precise employee data. Even a tiny mistake in job classifications, salary details, or personal information can lead to payroll errors, discrepancies, and fines.
Use standardized forms to collect data during onboarding and update the records regularly to reflect changes in the systems. This allows your professionals to process payroll precisely and minimizes payroll errors.
How Payroll Errors Impact Your Business
Payroll errors affect a company in many ways. It can disrupt operations, reduce employee trust, and make you pay a massive penalty. Below are a few ways in which your business is affected if there are payroll errors.
- Employee Dissatisfaction: Employees expect timely and accurate paychecks to manage their monthly finances. Payroll errors like incorrect deductions, misclassification, and late payments develop mistrust and frustration among them. Disappointed employees disengage from work, directly impacting the company’s productivity. As a result, the company may lose employees and have to invest in new hiring.
- Legal and Financial Penalties: Payroll errors could violate tax and labor laws that affect the company’s reputation and client trust. Errors like misclassifying employees and incorrect tax withholdings result in penalties, fines, or legal actions.
- Administrative Overload: Fixing payroll is often time-consuming and requires effort from finance teams and HR. They have to investigate discrepancies, address employee concerns, and recalculate tax payments. This affects their regular workflows and work quality. As a result, company growth will slow down while resource consumption will increase.
- Audit and Compliance Risks: Labor departments or tax authorities often conduct audit operations in your company to identify payroll errors. An audit is time-consuming and requires clarifying and verifying previous documents and records. Inaccurate data could again lead to deeper audits and fines as per the law.
- Financial Losses: Apart from penalties and fines, payroll errors may result in overpayments, duplicate payments, or underpayments. Also, employee turnover and legal disputes due to payroll errors incur significant costs.
6 Best Practices for Accurate Payroll Management
Accurate payroll management is essential for businesses. I’ll discuss 6 best practices you can consider to improve payroll accuracy, simplify your payroll processes, and reduce risks.
1. Double-check Details
While updating details and distributing paychecks to your employees, always double-check to ensure everything is correct. It involves cross-verifying timecards with proper payroll data, introducing a second review by another team for calculations, and generating payroll reports with recent bank statements.
Your finance team can detect overpayments, misclassification of employees, missed deposits, false calculation of deductions, and other discrepancies by double-checking. This prevents you from getting into regulatory troubles and saves your resources, time, and reputation.
2. Create Clear Payroll Policies
With clear and well-documented payroll policies, you can maintain consistency and compliance throughout the payroll process. Specify payroll deadlines to simplify payroll processing and ensure employees get their paychecks on time.
Outline clear holiday and overtime pay rules to calculate additional compensation during payday fairly. You can also explain tax and benefit deductions in detail to clarify how deductions are estimated and applied to the gross pay.
Make these policies accessible to your new and existing employees through materials, handbooks, or branch meetings. Transparent communication reduces confusion and builds trust among employees.
3. Set Up Payroll Calendar Reminders
A payroll calendar helps you avoid missed deadlines and fines. In the calendar reminders, you can highlight critical tax dates, schedule payroll processes, and accommodate holidays. This lets you plan processing cycles, so your employees get timely paychecks without errors.
By setting up payroll calendar reminders, your finance team can process payrolls on time, stay compliant with laws, adjust employee schedules, and update details accordingly. So, there will be no missing deadlines or chances of overpayment and underpayment during payday.
4. Utilize Direct Deposit and Paperless Payroll Options
Switch to direct deposit and paperless payroll options for better efficiency and security. Direct transfers reduce errors and delays associated with physical checks. When you choose digital payments, you eliminate the risk of losing sensitive information. Paperless payroll also cuts administrative costs and supports sustainability initiatives.
Encourage your employees to adapt to modern methods of payment for convenient and error-free transactions. This way, your employees will get accurate and timely payments directly to their registered bank account.
5. Monitor Payroll Metrics Regularly
Payroll metrics help you understand the areas where you need to improve and make better decisions. So, monitor your payroll metrics consistently to get valuable insights, such as overtime and labor costs, employee turnover rates, and error rates.
Using these metrics, you can identify the underlying causes of mistakes. They also detail how extra work hours and compensation will impact the payroll budget. Monitor your finance team’s operations to improve your operational efficiency and payroll accuracy.
6. Use Employee Self-Service Portals
Employee self-service portals help companies reduce administrative workload and errors. Let your employees create their accounts in the payroll software and update their own details to eliminate payroll errors.
Your employees can view and download important documents to access their tax forms and paystubs through the self-service portal. The portal includes log-in and log-out timings and time-off requests to automate the process of calculating payments accurately. The self-service portals also increase transparency and employee satisfaction.
Mitigate Payroll Errors With Automation and Updation
Avoiding common payroll errors is a necessity for companies to maintain financial stability, compliance with laws and regulations, and employee happiness. While payroll management will require your finance and HR teams to be hands-on, my recommendation would be to use payroll software to manage time constraints and errors.
There’s enough evidence to support this as well. Automated payroll software reduces your payroll processing time by up to 90%, leading to cost and labor savings.[4] This was assessed in a study by Forrester Consulting for Paycom, an HR and payroll solution.
So to prevent payroll errors, use reliable payroll software, conduct regular audits, and keep up with payroll laws. This way, you can achieve better payroll efficiency and eliminate risks.