Three Common Payroll Problems And How To Handle Them

In 2013, the Internal Revenue Service administered 6.8 million penalties for payroll reporting errors, costing businesses $4.5 billion, according to IRS data. About 45 percent of businesses incur an average of $845 per year in payroll penalties, according to statistics cited by the SBA. In addition to IRS penalties, payroll problems can hurt your cash flow, create friction with your employees and threaten the livelihood of your business. Here are some tips on how to avoid some of the most common payroll mistakes. 

Misclassifying Employees as Contractors

One of the most common payroll mistakes is misclassifying employees as independent contractors or vice versa, according to Accounting Today. How you classify employees affects whether you use a W-2 or 1099 to report their compensation, whether they are subject to federal income tax and employment tax withholding, and whether they are entitled to benefits. 

Avoid this problem by correctly classifying employees and contractors when you hire them. If you discover you have improperly classified employees, you should check into the IRS' Voluntary Classification Settlement Program. The VCSP lets eligible employers reclassify workers as employees for future taxes, while providing partial relief from federal employment taxes by letting you pay 10 percent of the liability that would have been due during the past tax year under reduced rates.

With respect to contractors, you should obtain a W-9 before paying them to avoid a potential mandatory backup withholding at a 28 percent rate. You must also generally issue a 1099 to contractors to avoid penalties, with some exceptions as in the case of contracting corporate entities. For both employees and contractors, avoid paperwork problems by using the Social Security Administration's website to verify Social Security Numbers.

Running Short to Pay Employees

Insufficient cash flow can cause payroll problems for your business when you find yourself running too short to pay employees. Failing to pay your workers can get you in trouble on several fronts, the SBA cautions. Unpaid workers can file wage claims against your business. In addition, you may also be subject to IRS fines for failing to pay quarterly payroll taxes as well as Department of Labor penalties for failing to meet minimum wage and overtime compensation requirements under the Fair Labor Standards Act.

Good financial planning is the best way to avoid this problem. When you do fall short, Inc. suggests a few strategies you should take. Notify your employees as soon as you find out there's a problem, so they can adjust their own finances, instead of springing a nasty surprise on them at the last minute. Cut your own salary before cutting anybody else's. Look for receivables you can collect and inventory you can liquidate to raise cash. Seek financing from your own savings and credit lines, family, friends, bank loans, hard lenders or payday loans. If you have Sage Payment Solutions, you can use Sage's partnership with Kabbage to get offers from multiple lenders and get money deposited into your account in as little as a few hours. Finally, review the situation and restructure your business to lower overhead, so you can avoid repeat problems. 

Paying Payroll Taxes Late

Another common problem that can become costly is depositing payroll taxes late. In general, businesses are required to make deposits of taxes on a monthly or semi-weekly basis, or the next business day when taxes reach a certain amount. According to the IRS, penalties for late deposits start at 2 percent for the first 1 to 5 days, increase to 5 percent after 6 days, rise to 10 percent after 15 days, and increase to 15 percent following 10 days of receiving an IRS notice.

The best way to prevent these penalties is combining good bookkeeping with automated notifications and deposits. If you do end up depositing late, you can attempt to convince the IRS there was a reasonable delay and request a non-assessment or abatement by using Form 843, Claim for Refund and Request for Penalty Abatement.

Although there are other common payroll problems, most of them are easy to avoid or handle if you are following good business practices. Stay on top of your finances to be sure you don't end up wasting money in fees and penalties.