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.

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#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 – Misclassification 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.