When hiring employees, one of the most important functions a small business performs is managing employee payroll accounting. Payroll mistakes can be costly and can have financial, legal, and reputational consequences. These are some of the payroll accounting mistakes that small businesses commonly make.
Miscalculating Taxable Income
It is not uncommon for some employers to provide employees with certain employment benefits outside of their salary. These might include compensation for personal and business expenses, such as subsidized housing, transportation, or a low-interest loan. The Canada Revenue Agency (CRA) considers these payments taxable benefits that need to be reported as they occur by both the employer and the employees. For failing to report the income, employers face non-compliance penalties and a greater threat of an audit from the CRA. Employers can avoid these liabilities by applying the applicable source deduction remittances according to the established payroll schedule.
Mismanaging Payroll Deductions
Aside from paying their employees on time, calculating Canadian payroll deductions and remitting them according to the appropriate schedule is the most important payroll accounting function that small businesses perform. By law, employers need to deduct three things from employee paycheques:
- Income taxes
- Canada Pension Plan (CPP) contributions
- Employment Insurance (EI) premiums
The CRA website has tools for calculating the correct amount of income taxes, CPP contributions, and EI premiums to deduct. It is the employer’s responsibility to ensure the correct amount of gross income, including non-salary taxable benefits, is recorded. Once the deductions are calculated, a remittance form must be submitted to the CRA by the prescribed deadlines. Employers that fail to remit deductions on time can be subject to penalties. To avoid penalties, employers should create a payroll schedule a year in advance that takes into account statutory holidays and leap years.
Misclassifying Independent Contractors
It is becoming a more common practice for small businesses to hire independent contractors for certain business functions as a way to reduce employment costs. However, if the CRA determines a contract worker is actually an employee, the employer can be subject to penalties and held responsible for all CPP and EI owed by the employer and the employee. The employee is responsible for paying unpaid back taxes.
When hiring an independent contractor, employers need to be aware of the “four-point test” used by the CRA to determine the nature of the relationship. The CRA is likely to classify a worker as an employee if any of these conditions exist:
- Control: If the employer has the right to hire, fire, and dictate the time, place, and manner in which the job is to be performed.
- Ownership of tools: If the employer provides any of the tools necessary to perform the job.
- Chance of profit or risk of loss: If, through the relationship, the worker has no chance of making a profit or incurring losses beyond an agreed upon salary.
- Integration: If the worker integrates their activities with the commercial activities of an employer.
To avoid a confrontation with the CRA over the status of an independent contractor, employers should ensure that none of these conditions exist in the relationship.