The most common tax and payroll errors businesses make, numbers 1-5

Running a small business can be a rewarding experience, but it usually comes with a lot of additional work to make sure everything is taken care of properly. Because there are fewer employees, staff may wear several different hats and mistakes sometimes happen. 

This is especially true in regard to the complexities of payroll and employment taxes. Even a simple error in payroll has the potential to lead to major problems, such as pricey penalties.

Below are five common mistakes that your business may encounter when it comes to managing payroll.

1. Categorizing employees incorrectly

Understanding the difference between an employee and a contractor and an exempt employee and a nonexempt employee is essential for employers. Misclassifying individuals who work for you exposes your business to potentially massive government fines.

Employee: In general, when an employer controls an employee’s work, that worker is not an independent contractor but an employee. You must withhold and pay income, Medicare, Social Security and unemployment taxes from the wages that you pay to employees.

Independent contractor: According to the IRS, an independent contractor is a worker for whom “the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.” However, different jurisdictions may take other factors into account. Employers should check with the state in which they operate to ensure they are in compliance.

Exempt employee: Exempt workers are on a salary or on a regular hourly schedule with a paycheck that seldom varies. They usually occupy administrative or managerial roles. 

Nonexempt employee: Typically, nonexempt employees are hourly employees entitled to overtime when their hours exceed 40 hours a week. Failure to pay overtime to a nonexempt employee violates the Fair Labor Standards Act.

2. Incorrectly calculating or not paying overtime

A common error made by businesses is misclassifying which employees are exempt and nonexempt; nonexempt employees are entitled to overtime pay.  Other common mistakes include:



• Incorrectly calculating the overtime rate, which must be paid at 150% of the worker’s hourly rate. However, the hourly rate must also include commissions and bonuses.



• Excluding time that employees spend traveling for work, such as when reporting to a specified site, then are either transported or driven to a different worksite.



• Omitting time expended on mandatory training and similar activities.



• Not counting time spent on required training and other mandatory activities.



The Department of Labor gives employees two years from the date the underpayment transpired to recover those wages. In cases of deliberate underpayment for overtime, the DOL gives employees three years.

3. Failing to pay payroll taxes or meet tax deadlines

Managing payroll taxes is an ongoing responsibility for employers. The IRS and state(s) in which you operate dictate your payroll tax payment schedule. In general, your tax deposit should be made the same day on which you pay your employees or soon afterward. Your tax payments should also be consistent with your pay periods. If your employees are paid every two weeks and you pay your taxes monthly, for example, you could be assessed penalties.

4. Producing W-2s with errors

Common W-2 errors made by employers include misspelling an employee’s name; putting a decimal point in the wrong place; mistakes in the employee’s Social Security number; mistakes in the EIN; and miscalculations in employer-sponsored health coverage, retirement contributions, wages or tax withholdings. The IRS can levy fines of up to $200,000 for businesses that fail to correct such errors.

5. Improperly maintaining payroll records

Form I-9: By law, employers must keep every employee’s Form I-9, used to verify the identity and legal authorization to work of all paid employees in the U.S., on file throughout their employment with your business and then at least three years from their hire date or one year from their termination date, whichever is longer.

Form W-4: This form that determines an employee’s tax withholdings must be kept on file for at least four years.

Under the Fair Labor Standard Act, employers are also required to have the information below on file for every nonexempt employee:



• Full name and SSN.


• Full address.


• Date of birth for employees under age 19.


• Occupation and sex.


• Time and day when the employee’s workweek starts.


• Hours worked daily.


• Total number of hours worked weekly.


• Basis on which the employee is paid, such as $500 per week, $20 per hour, etc.


• Regular hourly pay rate.


• Total weekly pay.


• Total overtime pay for the workweek.


• All additions, deductions for the employee’s wages.


• Total wages paid per pay period.


• Date of payment and its corresponding pay period.