Top 10 Payroll Compliance Mistakes
While ignorance is bliss, it won’t help you get out of an employment tax or labor law penalty. We know business owners are juggling a lot of balls and under a great variety of pressures. We compiled this Top 10 list to help small business owners understand the most frequent payroll compliance issues they will inadvertently stumble upon.
#1 – Paying Employees Outside of Payroll
All payments you issue to your employees should go through payroll as they are considered a form of taxable wages, including commissions, holiday bonuses, and even that ski pass or concert ticket you thought would be a nice thank-you gift. Exclusions apply for business reimbursement expenses assuming you can account for them with supporting receipts.
What’s the impact? The IRS puts the burden on employers to accurately withhold the proper payroll taxes from payments to employees, so beyond the penalties for late tax payments, headaches surrounding refiling returns, and sending out amended W2’s, you might be on the hook not just for the employer’s tax expense, but also for the employee’s tax portion. This is particularly true if you wait for your CPA to discover incorrect payments while preparing your income tax returns.
Suggestion: Scrutinize every payment to your employees before you sign those checks, create a reimbursement procedure to account for receipts, and review your vendor payment list quarterly to make sure you can account for all payments to employees not issued via payroll.
#2 – Overtime Rules & The Work Week
The first way employers get tripped up unintentionally starts by confusing pay period hours with work week hours. Overtime for non-exempt hourly employees must be calculated based on a specific 7-day period of time regardless of how frequently the employees are paid. For example, if an employee worked 50 hours in week 1 and 10 in week 2, the employee would be due 10 hours of OT pay. In states like Colorado and California with daily/shift requirements, you need to be even more observant.
What are the penalties for non-compliance? They can add up quickly, but in short up to $1,100 for each violation plus back pay. If an employee files a claim against you, the agency is obligated to investigate and the burden will be on you to provide payroll records for at least 3 years and time-card records for at least 2 years for all your employees. Keep in mind, a complaint can be filed by any employee current or former for up to two years or longer if the violation was deemed willful.
Suggestion: First, use an automated time keeping software that can auto-calculate the accurate earnings based on your state’s rules. If you don’t use one ASAP’s timekeeping solutions, make sure the one you use is set up correctly for Colorado and/or any state you have employees. Second, make sure you are retaining those records for sufficient amount of time to satisfy the record keeping retention requirements.
#3 – Overtime Rules and Salaried Employees
The second common way employers get tripped up is by establishing a set salary for their employees and assuming that this decision alone will satisfy the exemption clauses protecting employee’s right to overtime pay. Paying an employee a set salary each pay period doesn’t make them exempt from OT pay by default. To satisfy the requirements of an exempt from OT employee there are specific requirements, best practices for deductions from pay, and wage benchmarks that must be met (see FLSA advisor). To make matters more difficult, there are pending FLSA rules changes that may soon go into effect that for one would raise the earnings an employee would be required to receive per week to $921 before an employer could classify them as exempt.
What are the penalties for non-compliance? Same as the penalties for “Overtime Rules & The Work Week”
Suggestion: Scrutinize your handling of salaried employees and use the FLSA Overtime Security Advisor tool to help insure your employees fit under all, not just some, of the requirements which must be meet to fully comply with the FLSA standards. Review your payroll procedures to make sure you aren’t inadvertently docking time from exempt employees that would potentially jeopardize the classification.
#4 – Tipped Employee & Overtime
The rate of overtime pay for employees receiving tip income should be based on the full minimum wage rate, not the lesser tipped minimum wage rate. ASAP’s restaurant clients likely noticed this as our systems provide two sets of pay types for hourly employees. These distinctions help us auto-calculate this deviation from the standard rate 1.5x OT calculations. If you have any questions about how to use/enter those hours, please let us know. To see the Colorado calculation examples on this matter; visit here.
What are the penalties for non-compliance? Ask any one of these 39 hotels and restaurants in Aspen who were audited by the Department of Labor in 2015.
Suggestion: If you are not a payroll client of ASAP yet, please be careful with this item. Too frequently these days many outsourced payroll providers are really just software providers, and they don’t appear to have the same safe guards or staff eager to help employers monitor for compliance issues. Take a look at your payroll reports and do the math to check their work.
#5 – Miss-classification of Employees (EE’s) as 1099 Contractors
While this is not new, it has been a hot item these days after in 2011 the State of Colorado and Feds started attacking it with a unified front. In general, the burden is on the company to prove the classification of any individual was accurate. Thus if you are paying any individuals as independent contractors you need to pay particularly close attention to the details. If you are uncertain which classification your worker should fall into, please reference our 1099 Contractor or W2 Employee Article as a starting point. If you rely on many independent contractors, reach out to a legal advisor that can help you build safe guards and protections into your procedures should you face scrutiny. Here are a few in Colorado we recommend: Gokenback Law, LLC & Bechtel & Santo.
How would this impact me? First, the state has made it easier than ever for employees to file a report of misclassification. If you face one of the random UI Audits, you’ll be asked to hand over detailed accounting records for prior years as well as payroll details. The payroll details won’t be your issue, those checks you issued directly from your QuickBooks file is where all the headaches start.
#6 – Confusing Pre-Tax versus Post-Tax Deductions
Some deductions are pre-tax; meaning they are taken out of your gross earnings before taxes and thus reduce the employee’s tax obligations and the employers tax expenses. The most common examples of permissible pre-tax deductions are those associated with employee’s share of health, dental and vision premiums, but even those are only allowed if you have an active Section 125 plan document. The second most common type of pre-tax deduction would be related to deferrals that employees have elected to make and put towards a company sponsored Simple IRA or 401K plan; these lower the employee’s Federal and State taxable wages, but not FICA wages. Nowadays confusion often arises when employee’s without a company supported retirement plan wish to make contributions to their individual IRA’s via payroll. An employee may elect to set this up, but those should be treated just like a deposit into a savings account rather than on pre-tax basis. Employers that self-manage their payroll in-house, using the payroll module inside QuickBooks desktop version, should pay particular attention to the software as it will easily allow a user to alter the default taxation settings on deduction codes. Which will result in taking a post-tax advance and incorrectly making it a pre-tax item. Less obvious errors can also arise when managing supplemental insurance programs such as AFLAC. Make sure you are distinguishing properly between the pre-tax AFLAC deductions (Personal Sickness Indemnity, Accident, and Cancer insurance) and the post-tax items (Short Term Disability and Life Insurance).
What would be the impact? If your S125 document wasn’t active and you are audited, you could be on the hook for a big number. That is because the IRS could make you re-state those otherwise permissible deductions as post-tax. If you goofed on some other deductions, the cost would be related to going back and restating those items properly thus additional tax, late penalties and re-filing costs.
Suggestion: Failure to re-renew a S125 plan document is easy to miss, so check your records and make sure your document is renewed annually. If you need an S125, let us know we can help you set one up for cheap.
#7 – Missing Tax Payment and/or Filing Deadlines
Back-End tasks such as filing reports/returns, making timely payments, and following up to tax notices/letters are where your decision to outsource your payroll to an established company like ASAP really pays off. Take for example an average restaurant with 30-40 employees in Colorado; they would have roughly 46 tax payments and 21 tax filings to process at various times throughout the year as well as a requirement to submit W2 copies to the SSA and Colorado Dept. of Revenue. Oh, and for you guys in the Denver metro area; you have local Denver OPT, Glendale OPT, Aurora OPT or Sheridan OPT returns to potentially monitor.
What’s are the penalties? 941 penalties can go up to 15% plus interest, missing a Colorado UITR filing deadline starts at $50 plus interest and Colorado Dept. of Revenue is up to 12%. If you or your bookkeeper falls asleep on these and waits for the 2nd notices to address, the penalties can easily exceed the annual cost of our payroll services.
Suggestion: While ASAP puts our name behind our 100% guarantee on our tax filing and compliance service, the end responsibility for any tax payment or filing issues lies with the employer. Thus even if you are outsourcing your payroll, be attentive. I tell people to go ahead and take the time to set up online access with the Dept. of Revenue, the Dept. of Labor even if you rely on us for tax compliance. It doesn’t hurt to log in every now and again to monitor your accounts directly. Also, the online access will make changing a business address much easier should you ever need it.
#8 – New Hire Reporting/Wage Garnishments/Child Support
Our founder, Richard, is fond of educating new employers about how dating all the way back to The New Deal, the government has been using employers to implement social policy. Employer’s requirement to report every newly hired employee to a state database is a perfect example. However, what starts with new hire reporting leads to employers being put in the position of discussing uncomfortable personal issues with employees such as child support orders, garnishments from collection agencies, and levies from tax agencies for back tax issues.
What’s the impact? This isn’t fun and with the rise in medical bills garnishments numbers are picking up. First, keep in mind the court protects employees from retribution by employers that discriminate against them because of a court order, so keep your cool. Still, employers need to be aware that failure to follow through on one of these orders can leave the employer responsible for any amount that should have been withheld from their pay. And on the first part, the Colorado Dept. of Labor can impose fines for failure to submit newly hired employees to the database.
Suggestion: Try to stay out of the emotional drama best you can, but pay attention. Make sure anyone checking the mail is aware of the issues here and knows to get these items to us fast so we can help you set up and respond properly to the court orders. Oh and by the way, don’t worry behind the scenes we are reporting all your employees to the proper state database.
#9 – Employee Work State Issues
In today’s digital world, there has been a steady uptick in employers hiring employees working in other states outside from where the company traditionally conducts their business. When this happens, you’ll most likely be required to register in the employee’s home state at various levels: secretary of state, dept. of revenue/taxation and unemployment/labor.
What’s the impact? Both from a payroll perspective and from a corporate sales and income side, this can open your company up to additional tax filing hurdles & costs. The additional payroll filings and demands are something ASAP can manage given advance notice and the employer tax expenses won’t change too greatly in most cases. However, there can be many unintended consequences for a business depending on industry and state in terms of corporate income, sales tax, use tax and other miscellaneous rules which vary from state to state.
Suggestion: Before you make the leap to hire an out of state employee, its best to discuss with your tax filer and/or attorney to insure you aren’t opening yourself up to additional issues unnecessarily. We’ve seen California for instance apply some of the strictest rules even in cases of a home based employee.
#10 – Health Insurance Premium Reimbursements
Health benefits can be a battle and at times it can feel like you’re damned if you do and dammed if you don’t. In November of 2014, the US DOL & IRS issued guidance that pretty much slammed the door on the ability for small employer’s to supply employees with any form of health reimbursements, additional earnings earmarked for health insurance, or direct payment of premiums that are purchased in the individual marketplace – even if that financial support was paid as taxable income. A year later and still there is a sense of confusion and disbelief around this item. For instance, in the past employers could set up Health Reimbursement Arrangements (HRA’s), but the guidance appears to have killed off those arrangements as well or the majority of them. There is still at least one large provider of these HRA plans who is still actively marketing their plans as “In Compliance”.
What are the penalties for non-compliance? $100/day excise tax per applicable employee (which is $36,500 per year, per employee) under section 4980D of the Internal Revenue Code.
Suggestion: We are advising employers stay away from heath reimbursements in any form including HRA’s until the courts settle this one with someone else as the guinea pig. If in the past you had supplied some sort of pay to your employees which was earmarked for health premiums, stop the practice. Either go to the ColoradoSHOP exchange and set up a plan for your employees or simply stop, and give your employees a raise of some sort that isn’t ear marked for health insurance premium support.