3 Hidden Problems That Surface When Building a Payroll System

By Ritika Puri

4 min read

Every entrepreneur dreams of having a well-oiled payroll system with zero hiccups. Unfortunately, business dreams rarely reflect reality: payroll is complicated and ever-changing.

When implementing a payroll system, you should expect to devote some time to troubleshooting bugs, smoothing the processes, and learning from unexpected fires. For reference, my co-founder and I have devoted more than a year to fully learning the ropes of our financial, payroll, and accounting software.

At the same time, payroll is something that countless businesses have already done. Even though every organization is different, there are some problems that you can avoid off-the-bat.

There’s no need to reinvent the wheel. Here are some common problems that entrepreneurs can avoid, avoid, avoid.

Payroll Problem #1: Mismanaged Taxes and Deductions

There are many moving parts to your payroll system. From a tax and deductions perspective, Charles Read, president and CEO of payroll advisory company Get Payroll encourages business owners to watch out for the following:

  • Pre-tax deductions that have been treated as post-tax deduction by the business or a previous service bureau. (Usually Insurance)
  • Lack of child support garnishments being processed.
  • Not understanding the requirements and rules for child support garnishment enforcement.
  • Back taxes and penalties that have not been filed or paid.
  • Not getting all prior wage and tax info.
  • Manual paychecks recorded only in accounts payable and not in the payroll for tax reporting or filing.
  • Uncashed payroll checks that need to be submitted to the state.
  • Employees not actually on the payroll.
  • No written policy for paid time off.
  • Family members not on the payroll for tax purposes that should be.
  • Misclassification of employees as independent contractors and vice versa.
  • No written cafeteria plan.
  • Benefits/bonuses/gifts/etc. that are income to the employee not being recorded as payroll.
  • Tax avoidance scams that the company has bought into that are illegal.
  • Not registering in all of the States that they actually have employees in.
  • Not recording executives as employees.
  • Buying a shell company without checking on the actual state unemployment rate the shell has in place.
  • Not understanding overtime rules.
  • Not understanding that Labor Posters can be had for free.
  • Not understanding the Fair Labor Standards Act.
  • Misuse of training wage provisions.
  • Not understanding the goals of the US Department of Labor and The State Unemployment department.
  • Not knowing about New Hire Reporting.
  • Not keeping adequate records on payrolls for IRS purposes.
  • Not understanding or knowing the rules for depositing and filing employment
    taxes; federal, state, local.
  • Not filing 1099s.

The best way to avoid this (partial) list of potential issues is to work with a tax advisor or consultant off the bat.

“Employers who try to deal with the IRS themselves get into worse hot water,” explains Read. “It’s advantageous to work with a CPA who is a payroll processing expert instead.”

Payroll Problem #2: Communication with Employees

Remember that your team does not have the same insight into your payroll system that you do as a business owner. Sometimes, from an employee’s perspective, the numbers don’t add up.

“A major problem that can surface when building your payroll system is tax withholding, as well as changing the number of exemptions, explains AJ Saleem, who owns a startup tutoring company, Suprex Tutors Houston.

“Certain employees would prefer a different way to withhold money and this can be a concern.”

One way to resolve potential miscommunication—and unnecessary employee disgruntlement—is to work with a benefits administrator. If you’re unable to hire a full-time point person for HR, consider working with a consultant or outsourced firm that can help your team members understand their withholdings.

Ensure that every employee feels confident in coming to you with questions. Communicate that payroll can be complex to manage, so everyone within your organization understands your side of the story too.

Payroll Problem #3: Business Unit Segmentation

Business owners need to track payroll across multiple departments and teams for effective cost management, forecasting, and future hiring. A common mistake occurs when business owners don’t prepare themselves at the infrastructure level to track wages across departments.

“If a client wants to track wage costs across different departments, the mapping must be setup correctly inside the payroll system,” explains Thomas J. Williams, a tax accountant who operates Your Small Biz Accountant, LLC.

“Otherwise, all the earnings are placed into one wage account, making the payroll reports inaccurate.”

The key to building a structured payroll system is to know your growth plans and trajectory. How will you want to track costs across teams, long-term, and how will these metrics involve your cost management and investment decisions in the future?

Avoid ending up in a payroll system laundry pile by creating clearly defined segments off-the-bat.

Final Thoughts

Streamline your payroll operations before your business goes through its first major growth spurt. And if you’ve already gone through a growth spurt?

If your business is showing signals of a potential upwards trajectory whether you’ve been in business for six months or six years,, the best time to streamline your payroll is now. The ideal time is when you hire your first employee or have the capital to invest—signals of a sustainable operation.

Why take unnecessary risk?

Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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