Payroll is about more than getting the numbers right. Implement good payroll practices now and you can save yourself from back taxes, IRS penalties, and even lawsuits. Even if you use a third-party payroll service, you’re still the one responsible for following federal and state regulations. Here are a handful of payroll mistakes to avoid.
1. Misclassifying Employees
Employers have to pay their portion of Social Security and Medicare payroll taxes — currently, 7.5 percent — on wages paid to employees but not for payments made to contractors. If you misclassify an employee as a contractor, you could be forced to pay back taxes plus stiff penalties from the IRS. Take a look at IRS Publication 15-A, a thorough guide [PDF] to who should be classified as a contractor and who’s an employee. In short, if you have extensive control over where, how, and when people complete their work, they’re probably employees.
2. Not Including Bonuses and Gifts
Those $100 gift cards or cash holiday bonuses you issue to your employees aren’t tax free. Employers should include the fair value of any prizes, gifts, and awards in the wages section on all employees’ annual W-2. Fail to do so and you’re technically paying employees wages under the table — something the IRS and your state government don’t look kindly upon. Note that items given to the employee for work duties — like a new laptop or iPad for the office — don’t need to be reported as wages.
3. Ignoring Garnishments
If you receive a wage garnishment, levy, or child support notice for an employee, you must comply. Receiving a garnishment notice means you’re obligated to withhold a certain dollar amount from an employee’s paycheck and send it directly to a third party. Garnishments can eat up your time and usually come with complex rules. Fortunately, the U.S. Department of Labor resources to help you through the process.
4. Not Getting Contractor Information Upfront
Businesses are required to prepare and send an annual Form 1099-MISC to all independent contractors they paid more than $600. Rather than scrambling before the deadline, collect all independent contractor information up front. A best practice for small businesses is to require all contractors to complete a form W-9 before the project begins. If you can’t get the information you need, you’ll need to follow strict IRS instructions [PDF] and possibly even withhold taxes from future payments to the contractor.
You still need to send a copy of the Form 1099 to the IRS even if you can’t get the contractor’s information. Leave any fields you can’t complete blank.
5. Lax Data Security
You may not have the same security standards that rival those of a a large company, but you must keep payroll records confidential. If you use a third-party payroll system, keep your username and password protected. Physical payroll files should be maintained in a locked filing cabinet. If payroll information gets out, it can lead to identify theft, data breaches, and some very upset employees.