Here’s how employers can ensure they’re adhering to labor and tax laws when calculating employee paychecks.
Here's what you need to know:
- It’s vital to stay on the right side of the law and keep employees happy with payroll compliance
- Common mistakes employers make include not setting up automatic payroll deductions and misclassifying employees
- Other payroll mistakes include leaving out PTO and vacation days and incorrect overtime calculations
- Employers also sometimes miscalculate deductions or forget to include bonuses
- Companies must ensure they set aside enough money to cover payroll
Payroll is tricky, and you’re bound to run into a few obstacles trying to get it right. The IRS estimates that nearly 1/3 of American employers make payroll mistakes every year. The average cost of these errors is about $850 per year.
Time card errors, miscalculated time punches, or incorrect gross-to-net calculations can affect employee paychecks. In addition, mistakes in withholding (W-2 reporting) and publishing employee pay data can encourage payroll fraud. Employees can also leave negative (public) employer reviews if they have not received their paychecks accurately or promptly.
There are more than 7 things that could go wrong in the payroll sphere, but we chose the 7 mistakes with the most impact. We want to ensure you keep your employees happy with payroll compliance and stay on the right side of the law.
Not setting up automatic payroll deductions
Every worker should receive all wages due when calculating payroll taxes like FICA (Social Security) and FUTA (unemployment). However, the IRS has specific guidelines about how much money you should withhold from each paycheck based on how many exemptions employees claim on their W-4s. This step is crucial if you have a remote workforce or don’t use a full-time payroll department.
To make it easier for your employees to save money, you should offer the option of setting up automatic payroll deductions. This allows employees to have a set amount of money removed from each paycheck and the remainder deposited into a savings or investment account.
Offer the option of setting up automatic payroll deductions.
Not all employers offer this option and may not make it easy for employees to find out how to set up deductions. Some employees may need to fill out a form and return it to their employer to get started.
So, save your employees the headache and arrange it for them. In addition, employees can save on their tax bills because their money comes out before taxes.
Misclassifying employees when calculating paychecks
In the United States, employers don’t have to pay employees a specific rate. However, if you have a set salary or hourly rate for employees, keep that information up-to-date.
Employees are either exempt or nonexempt. This designation determines whether they’re eligible for overtime pay and other compensation.
In addition, you have to provide lunch breaks, health insurance, and parental leave for your nonexempt employees. If you misclassify a worker as exempt when they should be nonexempt, you risk running afoul of federal laws.
The Fair Labor Standards Act (FLSA) requires covered (nonexempt) employees to receive overtime pay for every hour worked beyond 40 in a workweek. Unless exempt, covered employees must receive overtime pay at a rate not less than time and a half their regular pay rates.
A rule of thumb for determining if a worker is an employee is simple. Does the person work for you regularly? Do you set their schedule and pay their salaries? You would have a nonexempt employee and not an exempt independent contractor if you answered yes to these questions.
If your worker is exempt from federal or state minimum wage laws, the higher of either state or federal tax law will apply. However, even if they aren’t exempt from these laws, most states require employers to pay their workers at least $7.25 per hour regardless of any other obligations under federal law. So always double-check which rate applies before making final calculations.
Leaving out PTO and vacation days
When calculating your payroll, don’t forget to factor in vacation days or PTO. Calculating PTO/vacation is essential because it will help you meet your employees’ time-off needs and avoid potential payroll errors.
Omitting PTO or vacation can lead to costly mistakes. For example, if you accidentally leave out a week’s worth of vacation time from an employee’s pay, you could owe that employee a lot of money.
To avoid mistakes, make sure you understand your state and federal laws governing vacation and PTO. In addition, be sure to consult with an accountant, a payroll professional, or payroll software to help you get it right.
Finally, consider using a third-party payroll provider. They’ll tell you if an employee doesn’t have enough hours to use their paid time off.
Common incorrect and illegal overtime calculations
The law is clear on how to calculate overtime. It should be paid at 1.5 times the employee’s regular pay rate for all hours worked over 40 in a workweek — but not if your state has other laws that supersede this federal standard. Incorrectly calculating overtime can be costly to your business and employees, who may lose out on substantial pay they were due and deserve.
Employers need to be aware of the specific rules that apply to their state or jurisdiction.
Another common mistake is misunderstanding how hours worked in different time zones are counted. Employers need to be aware of the specific rules that apply to their state or jurisdiction.
There are also special rules for salaried employees and for employees who work on commission. It’s essential to get accurate information about the correct way to calculate overtime to avoid costly mistakes.
Some of the most common and illegal overtime errors include:
- Only using hourly wage to determine OT pay
- Forgetting bonuses and other remuneration in OT calculations
- Using mean work hours, regardless of the pay period
- Not paying for OT without advanced authorization
- Offering PTO to avoid paying OT
- Allowing or requiring work while clocked out
- Classifying any covered or exempt employees ineligible for OT
If you omit or undercut employee hours, you might expose your business to wage-theft complaints from employees.
Miscalculating deductions, benefits, or garnishments
One common payroll mistake is miscalculating deductions. The best way to prevent this is to calculate deductions before calculating gross pay to ensure accuracy. When calculating deductions, keep in mind that some benefits (like health insurance) are subject to FICA taxes, while others (such as voluntary 401(k)s are not.
You have to have the correct tax forms on file and issue W-4s to employees. If not, you may be paying your employees too much and not withholding enough in taxes.
Stay on top of your employees’ filing statuses and avoid nasty fines. Don’t forget to double-check your calculations regularly so you don’t forget any necessary deductions. If you don’t have the time to calculate, consider using a SaaS solution or hiring a payroll service to do it for you.
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Forgetting to include bonuses, wages, or overtime
As an employer, you’ll make mistakes from time to time when calculating overtime, which can lead to employees being underpaid. The most common overtime calculation mistake is failing to include bonuses in the regular rate of pay. This can lead to employees being owed extra money for overtime worked.
While bonuses are standard in many companies, they can be tricky to calculate regarding payroll. For example, you may have a bonus once or twice a year, and it could be enough to offset your payroll calculations significantly.
You must know how your company handles bonuses because there are several different ways to be paid out. For example, some workers receive them at the end of each month for outstanding work, while some get them as an extra paycheck once or twice a year. It’s also possible that your company will give bonuses in cash instead of salary increases (which would affect your gross wages).
For tax purposes, bonuses are considered supplemental income; this means that employers don’t need to deduct taxes since they’re not part of an employee’s regular paycheck. However, employers must report any bonus payments made during the calendar year on their W-2. Hence, your employees need to understand their total earnings and income taxes owed by tax day.
Not setting aside enough money to cover payroll
Not setting aside enough money to cover payroll can lead to bounced checks, missed payments, and other financial problems. Forget to pay your employees on time and you can expect employee dissatisfaction and even lawsuits. Employees may also start looking for other employment.
Have enough money saved up each month to cover your payroll expenses. This includes both the basic payroll costs, such as wages and benefits, as well as any bonuses or overtime that may be earned.
But be careful not to overspend. This can lead to financial instability and even bankruptcy. Find a balance so that you don’t spend too much on payroll but you also don’t go broke.
Payroll mistakes can be costly for your business
Errors are costly. Put the extra time and attention into ensuring you don’t make any errors. If you find yourself in a situation where your payroll is getting paid incorrectly, ask yourself:
- Do I have the correct data for each employee?
- If not, why is it missing from my payroll?
- Have I made any payments to these employees in error (vacation or sick days)?
If you answered no to any of these questions, it might be time for some serious self-reflection. The more mistakes you make, the more susceptible you are to penalties and IRS audits.
If you don’t like doing payroll (and most people don’t), then utilizing payroll software or hiring a professional might be the best choice for your business. Then, you can have peace of mind knowing that an expert is handling it and that you pay your employees on time and correctly.