A smooth payroll process is like oxygen: no one notices it when it’s present; but its absence makes it impossible to think about anything else. That makes payroll one of the least appreciated yet most important functions within a business. When done well, payroll can keep employees satisfied and help organizations avoid legal consequences. On the other hand, when payroll mistakes crop up, their impacts can ripple through an entire company. For example, one recent study by EY found that the surveyed companies had an “80.15 percent payroll accuracy rate” and that “each error cost companies, on average, $291 to remedy directly and indirectly.” Fortunately, the most common payroll errors are easily avoidable with education, proper planning, and the right tools.
5 Common Payroll Errors
Misclassification of Employees
The Fair Labor Standards Act (FLSA) provides benefits and protections (such as overtime pay and minimum wage) for most employees. Independent contractors, however, are not afforded these same protections. Likewise, exempt and nonexempt employees also have different legal rights. Some organizations slip up and misclassify their employees as independent contractors or exempt employees.
Not only can misclassification deny an employee important benefits and wages, it may also mean the government misses out on valuable tax dollars. If left unchecked, the resulting underpayment or overpayment can turn into a costly payroll error. For example, of the companies surveyed for the EY study, “12 percent were fined by a regulatory body (such as the IRS or state authority) for a misclassification or error”; their fines averaged $5,200 and were as high as $100,000.
Miscalculation of Pay
With overtime, commissions, deductions, PTO, and more, payroll administrators have a lot to keep track of when calculating pay. (For example, the general rule for overtime wages is to pay 1.5 times an employee’s regular wage for any time worked beyond 40 hours in a work week. Each state may have different policies regarding overtime, however, and companies should always comply with the law that is more generous to the employee.) Poor time-tracking capabilities can contribute to miscalculated pay. If a company doesn’t have a reliable way to track employee hours or paid time off, its chances of making a payroll overpayment or underpayment mistake skyrocket. Mistakes such as these will result in a payroll correction.
What is a payroll correction?
A payroll correction is required when adjustments must be made to amounts paid. Poor payroll organization (such as forgetting to account for vacation days) can cause the need for money to be added or subtracted from the original amount. Payroll regulations vary based on state laws. Some (such as those related to employees looking to recover lost wages from underpayment) can pop up as much as two years later, requiring a company’s payroll team to dig through historical data—a time-consuming process that could have been avoided if the mistakes had been caught early or prevented entirely.
How long does a company have to fix a payroll error?
Although legal time frames differ from state to state, the short answer is that errors should be paid promptly. Fixing shortages in payroll as soon as possible should help an organization avoid penalties. Labor laws require full payment for work completed, and most companies will either add the missing pay to the next pay period or cut a check between pay periods.
Missed Payroll Deadlines
Timing is everything in payroll. But with so many steps in the payroll process, missing a key deadline is all too easy. Because employees count on their organizations to deliver payroll consistently and on time, a company’s failure to stick to a reliable schedule can damage its employees’ trust in and opinion of the organization. Additionally, many states have pay frequency requirements, and failure to meet them may lead to penalties. Deadlines are equally important for payroll taxes, and missing a tax deadline can cost a company a considerable amount in late fees and penalties—and possibly lead to legal trouble as well.
Failure to Send Out Tax Forms
The end of one year and the start of the next are hectic times for payroll professionals. After a year of processing payments and taxes, organizations must send their workers all the necessary tax forms (W-2 forms to employees and 1099s to independent contractors who earned $600 or more). Failure to get the right forms to the right people in a timely manner isn’t just inconvenient for employees—it can also spell trouble for the company. Because tax rates are subject to change, organizations also need to be sure they are paying the right tax rate so they can avoid owing taxes and making payroll corrections.
Failure to Keep Complete Payroll Records
When it comes to payroll records, it’s impossible to be too thorough. The FLSA requires employers to keep three years’ worth of pay records, which include data on hours worked, payment rates, payroll dates, and more; some states require even more data. Not only do these records keep an organization safe in case of future audits, they also help it run payroll more smoothly. Without complete, updated records, a company risks miscalculating pay, misclassifying employees, and making other errors and oversights.
Best Practices for Preventing Payroll Errors
Preventing each error listed above takes a variety of strategies. Incorporating certain best practices into the payroll process can help companies avoid errors entirely, thus making payroll faster, easier, and more accurate.
Invest in the Right Payroll Services
The best way to keep payroll mistakes from disrupting an organization is to invest in payroll services and a human resource information system (HRIS) that are compatible with each other. The right HRIS will manage and update important employee information (such as wages, hours, account numbers, and withholdings) and then communicate those changes to the payroll system, thus eliminating the need for double entry. At the same time, the right payroll software should sync with the company’s HRIS to automate the most time-consuming tasks and make it easy to run reports, file taxes, distribute pay stubs, and more.
Maintain Payroll Compliance
Many payroll errors are the result of payroll administrators not having enough information or not having the correct information about payroll compliance. Because laws and policies are always changing and can vary from state to state, it’s crucial for a company’s payroll team to stay in the loop with current regulations for where the organization is located (especially if it has a national or global presence).
Doing some basic research and double-checking assumptions can go a long way toward helping companies avoiding payroll errors. For example, payroll teams should be sure they can answer the following questions:
- What’s the difference between exempt and nonexempt?
- Is this employee classified correctly?
- What are the state regulations for this employee?
- How will we audit compliance when new regulations are released?
Run Reports Prior to Processing Payroll
Running a few key reports before processing payroll can help a company catch and prevent mistakes:
- A deductions summary lists all deductions for every employee.
- A payroll register presents all payroll information.
- A cash requirement report shows how much money the organization must have available in order to meet payroll. This data is broken down into categories such as wages, taxes, and deductions.
Keep Lists of Critical Information
Even with software to support their processes, payroll administrators have a lot to keep track of. A payroll process checklist enables them to review each step of the payroll process every time and make sure that everything is accurate. Organizations may also want to keep lists of all new hires, all pay changes, all deduction changes, and other updates in one central location, organized by pay period. Then, when it’s time to work on that period’s payroll, payroll managers can review each list to ensure that all the changes have been accurately added to the system.
How to Fix Payroll Errors
A company that has already processed an inaccurate payroll should take action to fix the error as soon as it realizes the mistake and, if necessary, report the error to state and federal entities. In some cases, the organization could face penalties and fees as a result of an error, and such penalties will increase the longer they remain unaddressed.
One of the following solutions usually suffices to address more minor payroll errors:
- Cancel the payroll immediately, make updates, and reprocess it.
- Run an additional manual payroll with the necessary adjustments for only the affected employees.
- Make adjustments on the next payroll to counteract previous mistakes and get things back in balance.
Improve the Payroll Process
Being aware of the most common payroll mistakes is a great first step toward avoiding them and maintaining a smooth payroll process. And although running a seamless payroll may sometimes feel like a thankless job, it affects many other elements of the larger organization, such as employee satisfaction and even company culture. The fact that most companies achieve just over 80 percent accuracy in payroll can seem encouraging, but it’s important to remember that even small payroll mistakes can add up over time. By establishing good payroll practices and partnering with solutions to help avoid errors, an organization can save time and money—and avoid headaches.