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7 Costly Payroll Errors and How to Avoid Them

Nothing interrupts a peaceful moment like an email subject line that reads “URGENT! PAYROLL ERROR!” Mistakes happen — but payroll errors are incredibly costly, both financially and to the health of your business. These mistakes can lead to financial penalties and the time and money required to correct them. According to IRS estimates, around one-third of US employers make a payroll mistake each year. We’ve explored the possible errors and compiled this list of seven costly errors to avoid during your payroll processes.

1. Using Paper Timesheets and Punch Cards

The American Payroll Association found that roughly 40% of small businesses incur an average of $845 a year in IRS penalties due to manual payroll processes. If your business is still using paper timesheets and punch cards, then you’re leaving the health of your organization at risk in a major way. We can help you go digital ASAP.

2. Miscalculating Overtime

Overtime is a more complex component of running payroll since it differs from your employee’s standard rate. Notably, you’ll face fines and wage interest if you don’t pay the accurate overtime rate—which is 1.5x regular wages at the federal level but may differ in your state or city. The person who handles your payroll needs to be an expert on the nuances of your local overtime pay requirements and possess excellent attention to detail. 

Additionally, overtime payment errors can arise if you miss a payment in any of the following scenarios:

  • When employees work during break times
  • When employees spend time traveling between work sites
  • When employees are required to participate in activities outside of regular hours, such as trainings, classes, or seminars

In a famous case, a Texas construction company underpaid an employee $608 for overtime work and paid more than $42,000 in penalties for the error.

3. Underpaying or Overpaying Employees

Underpaying and overpaying employees can have a severe impact on your business. The most apparent reason is having to pay back employees who have been underpaid, sometimes with interest or additional penalties tacked on. 

According to an American Productivity & Quality Center (APQC) study, organizations take between two and ten days to resolve a payroll error. The outcome can cause significant frustration for employees who are dependent on their paycheck to pay bills and even lead to the loss of team members.

In comparison, overpaying holds a more obvious financial penalty. Overpaying employees can happen for several reasons. Some of the more common causes of overpaid employees include:

  • Data entry mistakes: In some cases, when entering payroll data, there can be a mistake that results in the overstatement of hours.
  • Time clock errors: Time clock errors occur when you add hours to an employee who has missing or inaccurate punches.
  • Bonus pay withholding discrepancies: When you pay an employee a bonus, they may want taxes withheld at a different rate from their regular withholding, and errors can arise when you don’t process the compensation accordingly.  
  • Wrong employees: Sometimes, you may pay an employee another worker’s hours in error.

4. Paying the Wrong Tax Rates

Tax rates are constantly evolving, and there are many rates you need to be aware of for your employees. In addition to the federal and state income tax rates, you should also be aware of Social Security and Medicare tax rates, local income tax rates, unemployment tax rates, and any other taxes you’re subject to. Don’t assume that these figures remain the same year to year, and keep up to date with any changes.

5. Misclassifying Employees

Beyond fines, employers who misclassify workers or violate laws governing minimum wage or overtime pay also open themselves up to class action lawsuits and, in rare cases, even jail sentences. The difference between a full-time employee and an independent contractor should adhere to state laws, and the implications for wages are significant. Contractors aren’t required to make minimum wage or qualify for overtime in most areas. 

In addition to these noticeable losses, you’ll also have to pay additional taxes, fines, and interest for the misclassification itself. Make sure every employee classification is correct, and revisit your classifications regularly to confirm your business remains compliant.  

6. Mishandling Payroll Compliance

The IRS requires you to keep meticulous records in case of a potential audit down the line, and if your processes aren’t up to par, you’ll pay fines for your inadequate records. It’s easy to think that this issue will never come up, but it’s a costly mistake if you’re not careful. 

7. Data Entry Errors & Outdated Processes 

Manual data entry presents the potential for numerous errors listed above. If your payroll process involves a large portion of manual entry or outdated payroll systems, the likelihood of making these errors increases.

As you can see, there are various ways to make payroll mistakes, and unfortunately, some of them are especially difficult to avoid. If you’re looking to protect your peace of mind, outsource your payroll process to a co-employer and leave these steps to your dedicated third-party team of experts. Want to learn more about payroll support? Contact us here.

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