Payroll Mistakes to Avoid When Growing a Small Business

A woman sitting at a table, focused on her laptop screen while working.
By Joe Sharpe | 07/27/2023 | 18 min read

As small businesses prioritize growth and providing successful products and services, sometimes pivotal HR processes like payroll fall by the wayside. Payroll is an essential business function that impacts taxes and compliance, but also affects deeper dimensions of your business and workforce: employee satisfaction, employee retention, and talent attraction.

When your business’ payroll is processed in-house using manual methods (or a disjointed set of digital tools), you risk detracting from other key business tasks, losing valued employees, attracting compliance-related penalties, and committing payroll errors that cost your business time, money, and reputational standing.

Research from The Workforce Institute reveals that nearly 50% of American workers begin searching for a new job if they experience just two payroll-related issues (a late or inaccurate payment, for instance). In addition to these concerns from an employee and workforce perspective, the IRS reports that 40% of small and mid-sized businesses attract penalties and fines due to inaccurate payroll filing.

In this article, we’ll explore common payroll mistakes you can avoid when growing a small business, and best practices to ensure payroll compliance and streamlined payroll processing – including through the use of leading-edge HR software.

What are the top payroll mistakes to be aware of?

Whether it’s misclassifying workers, running payroll late, failing to adapt to payroll laws, or neglecting to store payroll records, a number of payroll mistakes can lead to compliance or employee retention issues. Let’s explore the most common small business payroll mistakes and how they can be addressed.

Misclassifying Workers

As a small business, your workforce may include some combination of full-time and part-time employees, as well as independent contractors. Sometimes it can be difficult to properly designate a worker based on their schedule, contributions to your business, use of company (or independent) equipment, and other factors. Fortunately, the IRS provides some clear guidelines to help you determine the correct designation for your workers. Working with a qualified payroll provider can also help you ensure that your existing employees and any new hires are correctly classified and that taxes and withholdings are automated for each employee within your payroll software.

Remember that if you determine a worker is an employee, they are likely entitled to overtime and minimum wage (which varies by state and locality), and you must pay the employer’s share of any applicable payroll taxes while withholding income tax from each employee’s paycheck.

Additionally, any small business must evaluate exempt vs. nonexempt status using Fair Labor Standards Act (FLSA) regulations as a guide. Generally speaking, exempt employees occupy an executive, administrative, professional, outside sales, or IT-related role within your business and are paid a salary (not by hourly rate); however, some other considerations apply. Exempt employees are not eligible for minimum wage or overtime pay. In contrast, nonexempt employees must receive overtime pay for any completed work past the 40-hour standard work week or beyond an eight-hour work day (in some states).

Incorrect Payments (Wages and Overtime)

Underpayment of employees is a regretfully common occurrence, with recent data showing that total US minimum wage violations exceed $15 billion annually. Small businesses that can consistently avoid this issue stand to distinguish themselves in their industry and earn the trust and loyalty of their workforce by providing timely and accurate payments on a consistent basis. Of course, payroll software significantly reduces the likelihood of employee underpayment and makes it easy to resolve (and transparently confirm) any issues should they occur. Using a streamlined payroll platform also makes it easy to demonstrate and resolve issues with overpayment, avoiding disputes with employees due to inaccurate payroll recordkeeping.

Overtime miscalculations are also more likely to occur when using a manual, in-house process. Federal policy dictates that employers pay time and a half the standard pay rate for any hours beyond 40 in a given work week, but sometimes local or state laws alter not only the pay rate, but also overtime pay for work days that exceed eight hours. To avoid penalties, lawsuits, or employee retention issues, it’s essential to be cognizant of all current or forthcoming local, state, and federal laws that affect overtime pay in the jurisdiction(s) where your business operates.

Pay Scheduling and Pay Frequency Issues

Many states mandate a minimum payment frequency for employers across industries and occupations. Although some states allow monthly payment, more have adopted semi-monthly or weekly requirements. The U.S. Department of Labor offers a guide to help employers determine their pay frequency obligations by state. Employers that do not abide by pay frequency requirements in the state where they operate are subject to fines, and vulnerable to employee lawsuits.

Even if your small business operates in a state where pay frequency isn’t dictated by state law, it’s vital to solicit employee feedback regarding preferred pay frequency and payment method (direct deposit being the most common employee preference). Once this information is gathered, it’s best to utilize payroll software that allows you to launch and automate payments, using employee-provided financial information to pay via direct deposit or another preferred method. Ultimately, establishing a payment method and pay frequently that aligns with employee preferences can be a major investment in employee satisfaction and employee retention.

Support from a qualified payroll provider also ensures that your business is prepared to make timely payments around local, state, and federal holidays (including bank holidays), and to fulfill company policies you have regarding overtime pay for work completed during holidays.

Miscalculating Payroll Tax Rates or Misunderstanding Payroll Laws

Payroll tax requirements can be quite complicated due to a combination of local, state, and federal requirements based on jurisdiction, business size, industry, workforce composition, and many other factors. In addition to these concerns, payroll tax laws are constantly evolving and not only affect tax payments and withholding requirements, but also labor law poster display requirements, IRS & FLSA recordkeeping regulations, and more.

How do common payroll mistakes impact my business?

Miscalculating tax rates or incorrectly interpreting payroll laws can lead to significant fines, employee lawsuits, and reputational damage, all of which is avoidable when your business uses payroll software that is capable of automating payroll tax requirements into a streamlined digital platform. When you work with a qualified provider, you also gain access to payroll experts with years of experience in tracking and adapting to shifts in payroll and related HR regulations.

Payroll mistakes can have even deeper consequences for small businesses, including employee dissatisfaction, employee retention issues (especially over underpayment or late payments), and diminished focus and efficacy with key business projects. Manually processed payroll invites human error into the process and makes it less possible to provide employees with a convenient, transparent payroll experience that aligns with their preferences regarding payroll frequency, payroll method, and 24/7 access to a mobile self-service portal.

How can I avoid payroll errors?

After soliciting feedback from your workforce about payroll frequency, payment method, and how they would like to access payroll information, switching from a manual/in-house payroll process to working with a digital platform is a must. Any software you choose to support your business’ payroll process should be paired with support from payroll and compliance experts who can help you stay up-to-date with any regulatory changes and automate your payroll platform accordingly.

Optimize Payroll and Compliance

Payroll errors resulting from a disorganized manual process can lead to legal issues, financial penalties, dissatisfaction in your workforce, and reduced focus on the central goals of your business and its ongoing development.

That’s why we offer a comprehensive payroll solution to help you simplify payroll management, boost employee satisfaction, and avoid costly payroll mistakes. We pair our leading-edge software with access to an assigned Payroll Guide who will work with you on all of your tax, compliance, and HR concerns throughout the entire process. Take the first step towards streamlining your payroll process to ensure long-term compliance, employee retention, and business growth.

DISCLAIMER: The information provided herein does not constitute the provision of legal advice, tax advice, accounting services or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional legal, tax, accounting, or other professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation and for your particular state(s) of operation.