Payroll processing can seem complicated, especially if you’re doing it for the first time, or if the person who previously handled it has moved on from your company.
Unfortunately, payroll mistakes can be serious – and could end up getting you fined by the IRS. Small businesses can even end up getting into debt or having to declare bankruptcy due to making huge payroll mistakes.
At the very least, you might have to take out a small business loan to get back on track. So what can you do to prevent payroll errors? Here are seven important steps to take.
1. Classify Your Employees Correctly
In the USA, all employees are classified as either exempt or non-exempt from the Fair Labor Standards Act (FLSA) requirements.
It’s crucial to get this classification right. If you misclassify an employee as exempt when they’re not, you could end up facing penalties and hefty back pay for overtime.
Here are the key differences:
- Non-exempt employees must be paid a minimum wage. They receive overtime pay for hours worked after 40 hours/week. Additionally, in some states (e.g. California), non-exempt employees receive overtime if they work more than eight hours in a day.
- Exempt employees must be paid at least $35,568/year ($684/week). Their salary needs to be concrete – it can’t be changed even if they make a mistake at work. They also need to be in certain types of roles, like being in an executive, administrative, professional, computer, outside sales, or highly compensated role.
Remember, exempt vs non-exempt doesn’t mean salaried vs hourly pay. Many exempt employees are paid an annual salary and many non-exempt employees are paid hourly – but this isn’t always the case.
If you’re unsure how your employees should be classified, get expert advice on this. A simple mistake here could lead to a huge bill or even legal action in the future.
2. Decide How Often to Pay Your Employees
Most companies pay employees biweekly (every 2 weeks), usually on a Friday. Some adjust this a little to pay semimonthly (twice a month, usually on 1st and 15th or 15th and 30th).
Assuming it’s legal in your state, you could also opt to pay monthly. Some employers go the other way and pay their employees weekly.
If you have hourly employees, they’re likely to prefer being paid biweekly – and weekly is even better if you can manage it. This does add to your payroll costs, however.
3. Make Sure You Calculate Overtime Pay Correctly
Normally, non-exempt employees need to be paid time and a half (1.5 times their usual hourly pay) for any overtime past 40 hours per week. But some states have laws that supersede federal law – for instance, requiring time and a half once an employee works over eight hours in a day.
It’s crucial to ensure you understand the appropriate state laws about overtime pay, so you don’t make a costly mistake.
4. Stay Up to Date With Payroll Taxes
Payroll taxes are complex and subject to fairly frequent changes. You may need to pay local, state, and federal taxes – and you need to keep on top of any changes. If you have employees in several different states (e.g. if employees work remotely), then you may also find that payroll taxes differ between employees.
Issues like payroll taxes are covered on this payroll processing checklist, to help you make sure you have taken care of everything required.
5. Make Sure You’re Not Underpaying or Overpaying a Worker
A simple error in entering an employee’s hourly pay or salary could result in a big loss to your company. If you underpay an employee, you could face legal action – and late payment fees.
It’s important to correct an underpayment error as quickly as you can: not only to avoid fees, but also to maintain a good relationship with your employee.
If you overpay an employee, that’s also a problem. You’ll need to notify the employee before you attempt to retrieve the money and you’ll need to prove the overpayment. After that, you can deduct money from future paychecks – but not if that results in an hourly rate below minimum wage. In some states, you have to reach an agreement with your employee or have them consent to a payroll deduction.
6. Always Keep Accurate Payroll Records
If you don’t keep accurate employee and payroll records, you could face an audit and potentially a large fine.
You’re required by the IRS to keep records for all your employees that include information such as the amounts and dates of wages paid and copies of W-4 tax withholding forms.
For non-exempt employees, you also need to keep more detailed information, including a record of their hours worked.
You need to keep these records for at least three years, too.
7. Pay for Training and Time Spent Recovering for Injuries or Illnesses Related to Work
Non-exempt employees need to be paid for work-related training, lectures, or meetings. This includes online training – even if it’s done outside normal work hours. For instance, if you ask your employees to watch a 30-minute online video over the weekend, you need to pay them for it.
Most states require employers to have workers’ compensation insurance. This pays part of an employee’s wages if they’re absent while recovering from a (work-related) illness or injury. Again, making a mistake here could open you up to legal action.
Getting payroll wrong can be expensive … and it can also be hugely destructive to your relationship with your employees. Imagine paying someone a few days late when they’re relying on their wage to pay their rent. You could cause them serious problems.
Most employers – even small startups – use payroll processing software to manage payroll and run their business effectively. This helps take care of lots of requirements automatically.
If you’re new to payroll, though, or if you’re afraid of making a mistake, you may also want to get specialist advice. Spending some money now on good tools and advice could save you a huge amount of money, time, and hassle in the future.