When it comes to calculating the appropriate amount to withhold from an employee's paycheck, it's not up to the government to get it right; it's up to you. (Photo: Shutterstock)
One thing every employee looks forward to is payday. Whatever the cadence is (weekly, bi-weekly, or semi-monthly), checking their bank account for the correct amount or cashing their paycheck is the most they should have to worry about. On the front end of the transaction, however, much goes into ensuring those wages are paid correctly and on time. Not to mention all of the post-payroll requirements of paying and reporting the taxes.
Payroll is the most significant expense for most companies, and if not processed correctly, it can become even more expensive. One study found up to 82 million workers in America have experienced paycheck errors. The situation can quickly spin out of control when you combine the challenges of processing payroll from pay period to pay period with the quarterly payroll tax reporting obligations.
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As a small business owner, you understand time is one of your most valuable resources. If you happen to be responsible for processing payroll, your time is under constant pressure. However, companies must process payroll whether they have time to deal with it or not, and that can put a tremendous amount of pressure on you, making it easy to justify cutting corners. Payroll processing is a time-consuming, complicated, and frustrating task as, typically, business owners underestimate what it takes to pay their employees in compliance with the web of federal and state laws. On average, 5 hours per pay period is spent processing paychecks, and almost $7 billion is wasted annually on payroll errors alone.
Join our LinkedIn group, ALM's Small Business Adviser, a space where small business owners can gather to network, have discussions and keep up with the trends and issues affecting their industries. In 2020 and 2021 especially, many businesses were undoubtedly overwhelmed by the legislation passed for various COVID-related credits. Unfortunately, some companies missed out on credit opportunities due to the onslaught of new processes, policies, and rules. If you want to alleviate the headache that comes with payroll and payroll taxes for 2022, there are a few areas to consider.
Payroll tax non-compliance
When it comes to calculating the appropriate amount to withhold from an employee's paycheck, it's not up to the government to get it right; it's up to you. When you became an employer, you unwittingly became a tax collection agent for the Internal Revenue Service and state tax authorities. Unfortunately for you, the IRS has a solid motive to pursue businesses that get it wrong.
Payroll taxes withheld by employers account for nearly 72% of all IRS revenue collected by the agency, so you can see why accuracy and timeliness are so vital to them. However, one of the problems is that it takes the IRS and the Social Security Administration many months and even years before notifying you if you've made a mistake along the way. Payroll software alone won't ensure compliance. You'll also need experts in wage and hour, payroll tax, and Human Resources.
Navigating state specificity
Depending on where your business is located, the regulatory burden can be the difference between night and day. California, for example, recently ranked 49th out of 50, second only to New Jersey, as the worst state in the 2021 State Business Tax Climate Index. The Index is designed to show how well states structure their tax systems and provides a road map for improvement. The American Tort Reform Foundation ranked California #1 in their 2021 Judicial Hellhole report to make matters worse for the Golden State.
As a recent example, employees in California were provided supplemental paid sick leave for specific COVID-19-related reasons. The bill was signed into law on February 9, 2022, with an effective date retroactive to January 1, 2022. To make it even more challenging for employers, the law imposed strict pay stub reporting requirements that most payroll systems weren't designed to accommodate.
For multi-state employers, the process and knowledge needed to maintain compliance can be daunting. It's critical that you stay abreast of the many changes happening, or better yet, partner with a payroll service provider who can help you navigate these treacherous waters.
Misclassification of your employees
Most employers have a mix of full-time, part-time, and temporary employees, and a growing number also use independent contractors. Misclassifying employees as exempt when they should be non-exempt or incorrectly categorizing an employee as an independent contractor can create serious problems for you.
To help you determine if a worker is an independent contractor or an employee, the IRS has published Common Law Rules and an 11-point test. If you use independent contractors, you need to take some time to analyze the facts of your situation up against the 11-point test outlined in the standard law rules. Factors that are relevant in one situation may not be relevant in another. The 11-point test focuses on these three categories, behavioral control, financial control, and the relationship between you and the worker.
The quick explanation is this: If you have the right to control or direct only the work results and not how it will be done or what will be done, then you have an independent contractor relationship. If you think that's pretty subjective, it is. An IRS video on worker classification reveals there are no "magic" or "set number" of factors that make the worker an employee or an independent contractor. In the end, no one factor stands alone in making this determination.
Late tax filing?
Once you've correctly processed payroll, you'll need to pay and report the taxes you withheld to the IRS and state tax authorities, along with the matching FICA taxes and unemployment taxes.
Congress established significant penalties to deter employers from not paying their payroll taxes. The longer you delay paying, the more it will cost. The IRS is an efficient bill collector, and they will exact the funds from you. If you ignore them, they have a division that carries guns, and they'll show up unannounced and wreak havoc.
There are four payroll tax penalties you need to know:
- Failure to deposit
- Failure to pay
- Failure to file; and the
- Trust fund recovery
And here are four things you must do to avoid them:
- Make deposits, i.e., the tax payments, on time
- Make deposits for the complete and correct amount
- Make deposits in the proper manner; and
- File your returns on time.
As an SMB, it is imperative that you understand the implications of failing to comply with the payroll tax payment and reporting laws and that you closely monitor and verify that everything is complete, accurate, and on time.
It's essential to have the right expertise on your staff or find a resource to assist you with your compliance obligations. You went into business to produce a product or provide a service, not to be an employer or an agent of the government, but that's unfortunately what you are, and the cost of failure to comply is high.
Tom Lindsay is executive vice president of payroll operations at Vensure Employer Services, Inc.
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