Why Do So Many Small Businesses Use Pen and Paper for Payroll?

There is no more essential task for an employer than payroll. If you have people working for you, they’re going to expect a check at the end of the pay period. And if it doesn’t show, you probably won’t have employees for long.

Payroll can also be one of the most intimidating employer tasks. There are numerous regulations to be aware of, forms to file, and deductions to take. For example, will you deduct health insurance premiums, flex spending, or retirement contributions? How do you withhold taxes, Medicare, and social security? How many hours does an employee have to work before overtime kicks in? And what the heck is a FICA?

With all of these questions and the consequences that come from getting them wrong, it’s no surprise that so many small business owners find payroll to be daunting. But here’s what did surprise us: 25% of small businesses are still using pen and paper for their payroll records rather than investing in a reliable payroll software or accounting service.

Why? Let’s take a closer look at payroll accounting and manual record keeping.

What are the advantages of recording payroll by hand?

For the most part, there are four different payroll methods that companies can choose from:

• Manual (DIY pen and paper method)
• Staff Accountant (often part-time)
• Outsourced accountant or payroll service
• Payroll software

Sometimes, businesses combine two of those options. For example, a company might purchase a payroll software solution and also hire a part-time accountant to enter the data and operate the software.

As we’ve noted, a quarter of small businesses are choosing the manual pen and paper method for payroll. Why are they doing this? What are the advantages?

25% of small businesses are still using pen and paper for their payroll

Some companies might feel that manual payroll is the only option they can afford. Accountants, outsourced contractors, and payroll software all cost money. Perhaps these small business owners believe that paying for payroll is something they just can’t spend money on right now.

If they have a very small number of employees, say five or fewer, they might also feel that DIY payroll is simpler too. The employees report their hours, the boss does a few quick calculations and writes a check. Done. Easy, right?

Not so fast. If you’re doing payroll manually, you might be making errors that could cost you money and cause some complicated, far from simple problems in the future.

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What are some of the potential legal pitfalls to manual payroll accounting?

There are a number of mandatory deductions that employers must withhold from employee paychecks.

• Federal income tax
• Social Security and Medicare, also known as payroll taxes or FICA (Federal Insurance Contributions Act)
• State income tax
• Local tax (city or county taxes, state disability, and unemployment insurance)
• Court-ordered child support payments

Calculating these withholdings can get complicated. For example, the FICA taxes are divided into two categories, Social Security and Medicare. There are separate tax rates for each category.

To make it a little more complicated, there is a cap to the amount of income that is subject to the Social Security tax ($128,400 in 2018). But for Medicare, there is no wage base. Instead, earnings above a certain amount are taxed an additional 0.9 percent. The number of earnings that trigger the higher tax rate are different based on the employee’s filing status too.

FICA isn’t the only complicating factor. Here is a short and incomplete list of mistakes that an employer could make when calculating payroll by hand:

• Making mathematical errors in calculating hours or pay.
• Losing paper records.
• Failing to accurately read the IRS tax withholding tables.
• Miscalculating optional withholdings, such as health insurance premiums, retirement plan contributions, and so on.
• Failing to assign the appropriate pre-tax or post-tax status to particular withholdings.
• Not understanding the laws governing payroll in each state where you have employees.
• Not knowing the current social security base pay, or the current federal, state, and local tax rates in your area.
• Withholding too much or too little, which can change your employees’ gross pay amounts and throw off other calculations.
• Failing to withhold taxes on overtime, commission, or bonus wages.

Unless you are an expert payroll accountant yourself, keeping track of all that is nearly impossible.

What happens if you make a mistake?

If you make a mistake in your employee tax withholdings, you have to correct it. Let’s say that you have withheld too much from an employee’s paycheck. You’ll have to reimburse the employee. You can refund the employee the full amount right away, or you can withhold a little less from future paychecks until you’ve squared the withholdings. You can also choose to do nothing and let the employee handle it when he or she files a tax return.

But what if you’ve withheld too little? Someone has to pay the difference. You can choose to withhold a little more from the employee’s check each pay period until you’ve made up the difference. Of course, in that case, it will feel like a pay cut to your employee. You can choose to make up the difference yourself, which could be expensive for you. Or again, you could choose to do nothing and let the employee handle it at tax return time.

However, if you’ve withheld too little of the employer match FICA taxes, you will be responsible for making up the difference yourself. This could be costly if the mistake goes on for a long time. And if you’ve withheld too little on other benefits, such as health insurance premiums or retirement contributions, then you’ll have a complicated mess to clean up with your benefits administrator.

What if the error doesn’t have to do with taxes or benefits at all, but with some other payroll issue? Perhaps you’ve miscalculated an employee’s hours or failed to pay overtime. You could end up owing your employee back pay. If you don’t pay it promptly, you could be sued.

Regardless of how you choose to correct these mistakes, you will have to make corrections to the quarterly forms you’ve already filed with the IRS.

As you can see, manual payroll comes with a lot of potential pitfalls. Fixing these errors can make this payroll method anything but cheap and easy.

What are the benefits of payroll software?

If you only take away one message from this article, we hope it’s this: It is important to get payroll right.

If you want to run a successful business, you must pay your staff accurately and on time. Payroll mistakes, especially if they happen often, can lead to low morale, poor performance, and a bad reputation. It might even cause legal problems. A good computerized payroll system can help tremendously. It will make your pay run faster and more efficient. It will also give you the confidence of knowing that this essential business function is being completed error-free.

A good payroll software will:

• Calculate employee hours, pay and deductions automatically.
• Generate payslips with all of the legally required information.
• Calculate bonuses, overtime, expenses, PTO, etc, with little to no effort.
• Generate and print forms for reporting to the IRS and state agencies.
• Ensure compliance with federal, state and local regulations.
• Eliminate the need to understand complex tax tables and formulas.
• Store data in a secure, electronic location.

What should I know before switching to payroll software?

There are many different choices for payroll software. Some systems require manual data entry. These are typically less expensive, but they have fewer automatic functions.

There are full-featured software options available as well. These come with a full array of automatic payroll functions, including required reporting, data storage and employee time reporting. These often cost more money and they might require special computer equipment and skilled operators.

It’s important to research all of the payroll software options available to you. Decide how much money you are able to spend and which functions you’ll need.

But if you still have questions, we have answers. Download our Payroll Pocket Guide for easy instructions on how to select your next payroll solution.