6 Payroll Management Mistakes and How to Avoid Them

Woman reviewing payroll documents at her work desk
By Adam Walters | 06/07/2024 | 5 min read

Payroll management is one of the most important aspects of your business, and even a single error can lead to employee turnover or fines. To help your business do better, here are six of the most common mistakes businesses make when it comes to payroll management and what to do to avoid them.

1. Late payment

78% of Americans live paycheck to paycheck. This means their living expenses for each pay period equal what they earn. A late paycheck, even by a day, can mean that your employees don’t have the funds to eat or make payments on essential services like rent or utilities.

Because accurate, error-free payroll is such a necessity, employees will look for a new job. With only one payroll error, anywhere from 17% to 29% of employees will start to look to leave, but after a second payroll error, that jumps to 49%. Consistent late payroll payments will cause you to lose your workforce.

Employees may file lawsuits against you for unpaid wages depending on the frequency of late payments. This will cost you the cost of legal fees and charges, but you will also be responsible for back pay, which can cover up to the amount not paid and an equal amount of damages. For example, if there is $1,000 worth of missing payments and taken to court over that amount, you would be responsible for paying the missing $1,000 in back pay plus an additional $1,000 for damages. 

2. Incorrect tax amount

Employers must pay payroll taxes with every paycheck. If a business does not pay the correct amount, it is in violation of employment tax laws and will face consequences from the IRS.

The Tax Division of the US Department of Justice will pursue civil litigation and criminal investigations against those who were directly responsible for the crime and those who supported them. These cases carry stiff fines and substantial prison sentences.

3. Not paying the correct overtime pay

The Fair Labor Standards Act (FLSA) established the right to overtime pay and is going through continual updates. Not all employees qualify for overtime pay, so it’s important for businesses to track and manage each employee to ensure that they pay overtime for all correctly identified employees.

If an employer does not pay the correct overtime pay, they are subject to many of the same consequences as those met by late or missing payroll payments. Because these crimes are covered by the FLSA, they also carry some additional penalties including $1,000 fines for each violation. Typically the first violation does not result in jail time, but a second or multiple convictions may result in imprisonment.

4. Misclassifying employees

Different classes of workers are regulated differently and require different payroll solutions. A common mistake businesses make is incorrectly identifying workers as employees or independent contractors.

Employees are not the same as independent contractors. While there is much more complexity behind the differentiation between employees and independent contractors, the most basic understanding is that an employee works for someone else's business. In contrast, independent contractors work for themselves and contract their work to other businesses. For a more nuanced description, the Wage and Hour Division of the Department of Labor has released a final rule that provides a full description to help companies avoid misclassification.

Non-compliance with correctly classifying employees is a major issue affecting your business and employees. Because employees do not have the correct I-9 form on file, they’ll be subject to fines, criminal penalties, and court orders. However, if your business misclassifies an employee, no matter if it is by accident or an intentional choice to avoid tax payments, you will be subject to severe penalties, including fines and jail time.

Miscalculating pay

Miscalculating pay can include a company making an error in calculating the base pay for an employee, making an error in calculating payroll taxes, or both. Depending on where the calculation error exists, there are different consequences for the business.

If a company miscalculates the base pay for an employee, they can be held responsible in the same way as they would for late or missing payments. If a company miscalculates payroll taxes, they are faced with tax avoidance and will face the consequences of missing or partial taxes. If the business miscalculates both options, they may be subject to the consequences of both crimes.

Keeping incomplete records

Payroll has strict rules about document retention and security. The IRS requires an employer to retain payroll records for a minimum of four years, but some payroll professionals suggest a longer retention period of six years just to be safe.

As part of that retention, a business should retain:

  • Employer identification number (EIN)
  • Employer tax forms and payment receipts
  • IRS notifications regarding payroll taxes, including remittance frequency status
  • Tip totals for employees who are tipped
  • All documentation around sick leave
  • All documentation around overtime wages
  • Amounts and dates of all taxable wages, including bonuses and commissions
  • Complete employee information, including tax documentation

The IRS requires employers to keep payroll information for this period as part of an audit trail. If there are any questions or concerns about payroll or taxes, the documentation serves as a paper trail that can incriminate or exonerate the company or employee.

Avoid Common Payroll Mistakes with IRIS

IRIS Managed Payroll & HR services provide your company with complete payroll and HR coverage. We take complete ownership of your payroll, ensuring it is done correctly and on time, every time. We manage and take responsibility for all aspects of your payroll, so if there is ever an error or compliance question, we are responsible for all penalties and fees, leaving you and your business entirely removed from the problem.

Get started today and let IRIS manage your payroll so you can spend your time focusing on your business.