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The most frequent tax and payroll mistakes companies make, ranked 1-5

Posted by Shivali Anand

April 22, 2022    |     4-minute read (752 words)

Running a small business may be rewarding, but making sure everything is in order entails a huge amount of ongoing effort. Since you have fewer personnel, employees may need to wear several hats, which in turn can increase the likelihood of errors. 

This is particularly true regarding the intricacies of payroll and employment taxes. Even a minor payroll error can result in potentially harsh financial penalties. 

To that end, here are five frequent errors to watch out for with business taxes and payroll.

1. Misclassifying staff

Employers must know the difference between an employee and a contractor and an exempt employee and a nonexempt employee. Misclassifying employees exposes your company to potentially crippling federal penalties.

Employee: When an employer influences an employee's job, that employee is considered an employee rather than an independent contractor. You must deduct and pay income, Medicare, Social Security and unemployment taxes from these workers' paychecks.

Independent contractor: These are workers for whom "the payer has the authority to control or influence only the output of the job and not what will be done and how it will be done," according to the IRS. Other variables may, however, also be deemed applicable by other authorities. Employers should therefore double-check compliance with the state in which they operate.

Exempt employee: Exempt employees are paid a salary or work on a regular hourly schedule with a consistent salary. They typically work in management or administrative positions.

Nonexempt employee: Nonexempt workers are often hourly employees who are eligible for overtime when their number of weekly hours surpasses 40. The Fair Labor Standards Act makes it unlawful to fail to pay nonexempt employees' overtime.

2. Incorrectly calculating or not paying overtime

Misclassifying which employees are exempt and nonexempt is a not-uncommon error made by businesses, with the mistake being that nonexempt employees are entitled to overtime compensation. The following are some other frequent errors in regard to overtime:

• Miscalculating the overtime rate, which must be paid at 150 percent of the employee's hourly rate. Commissions and incentives must, however, be factored into the hourly rate.

• Excluding time spent commuting for work, such as when personnel report to a certain location and are either transferred or driven to another site.

• Excluding time spent on compulsory training and other such activities.

According to the Department of Labor, employees have two years from the date of underpayment to recover their earnings. The DOL provides employees three years in cases of intentional underpayment for overtime.

3. Not paying payroll taxes or missing tax deadlines

It is an ongoing responsibility of the employer to manage payroll taxes. Your payroll tax payment schedule is determined by the IRS and the state(s) in which you operate. In general, your tax deposit should be made on the same day you pay your employees, or soon after. 

Your tax payments should also be consistent with your pay periods. If your employees are paid every two weeks, but you pay your taxes monthly, for instance, you could be assessed penalties. 

4. W-2 errors

Misspelling an employee's name; inserting a decimal point in the wrong place; inaccuracies in the employee's Social Security number; problems in the EIN and miscalculations in employer-sponsored health coverage, retirement contributions, pay or tax withholdings are all common W-2 errors. Businesses that do not remedy such mistakes might face penalties of up to $200,000 by the IRS.

5. Not maintaining payroll records

Form I-9: Employers are mandated by law to keep every employee's Form I-9, which is used to confirm the identity and legal authorization to work of all paid employees in the U.S., on file for at least three years from their hire date or one year from their termination date, whichever is longer.

Form W-4: This form that determines an employee’s tax withholdings must be kept on file for at least four years.

Employers must also keep the following information on file for each nonexempt employee, as mandated by the Fair Labor Standards Act:

• Full name and social security number.
• Full address.
• Date of birth for workers under the age of 19.
• Work and sex.
• Time and day when the employee's workweek begins.
• Daily working hours.
• Total number of hours worked weekly hours.
• The employee's pay basis; for example, $500 per week, $20 per hour and so on.
• Regular hourly pay rate.
• Total weekly pay.
• Total overtime pay for the workweek.
• All additions and deductions for the employee's wages.
• Total wages paid per pay period.
• Date of payment and its corresponding pay period.

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