Mastering Payroll Compliance THE TOP 10 MISTAKES THAT COST EMPLOYERS MONEY

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1 Mastering Payroll Compliance THE TOP 10 MISTAKES THAT COST EMPLOYERS MONEY

2 EXECUTIVE SUMMARY Businesses pay government agencies millions of dollars each year in compliance penalties. And in this economy, agencies are more vigilant than ever about enforcing regulations. To help avoid fines, it can pay to be aware of common payroll pitfalls. Paychex serves over 500,000 small businesses in America and has developed tremendous insight into the common challenges and mistakes that small business owners face. Based on interviews with company leaders across the nation who talk to businesses every day, this paper summarizes the consistent payroll mistakes made by small business owners. To help avoid fines, it can pay to be aware of common payroll pitfalls. 1

3 WHO NEEDS AN EMPLOYER ID NUMBER (EIN)? You need an EIN if you: have employees; operate a business as a corporation or partnership; file an employment, excise, or alcohol, tobacco and firearms tax return; withhold taxes on income, other than wages, paid to a non-resident alien; have a Keogh plan; or are involved with certain organizations such as farmers cooperatives, estates, or trusts. You can apply for an EIN online, by phone, by fax, or by mail. See for details. Apply early enough to have the assigned number when you need to file a return or make a payment. If you apply by mail, it may take four to five weeks to receive your EIN. MISTAKE 1: MISCLASSIFYING EMPLOYEES VS CONTRACTORS Proper classification of a worker as an independent contractor may save a company money and benefits costs, such as pension, group health, and workers compensation insurance as well as Social Security and unemployment insurance taxes. In most cases, the only tax form employers need to complete is a Form 1099-MISC at the end of the tax year for workers classified as independent contractors. Classifying workers as employees, on the other hand, requires the company to withhold federal, state, and local income taxes; pay the employer s portion of the tax mandated under the Federal Insurance Contributions Act (FICA) for Social Security and Medicare; pay the full tax required under the Federal Unemployment Tax Act (FUTA) and any state unemployment insurance tax laws; pay for workers compensation; file a number of returns during the course of the year with the various tax authorities; and provide W-2s to employees by January 31. The employee may also have rights to any employee benefits offered, such as health insurance, vacations, holidays, or retirement plans. Because of the complexities in employing full-time employees, often small business owners are tempted to simply classify workers as independent contractors. Intentionally misclassifying employees as independent contractors may result in penalties plus interest. The exposure for unintentional misclassification of an employee is serious, but not as serious as the risk for an intentional misclassification. For more details about classifying employees, see the following: Independent-Contractor-(Self-Employed)-or-Employee%3F. If you have questions about how to classify a worker, ask your financial consultant or attorney. MISTAKE 2: EXEMPT VS. NON-EXEMPT Employees classified as exempt are generally exempt from some of the provisions of the federal wage and hour law, the Fair Labor Standards Act (FLSA). Employees exempt from the minimum wage and overtime provisions of the FLSA include the white-collar exemptions: executive, administrative, professional, certain computer professionals, and outside sales. These employees may also be exempt from similar provisions under state wage and hour laws. The FLSA requires employers to pay covered non-exempt employees at least the minimum wage for all hours worked in a workweek up to 40, and an overtime rate of one and a half times their regular rate for hours worked over 40. The U.S. Department of Labor (DOL) regulations contain information on what is compensable time under the FLSA. Disclosure of a single misclassification can trigger a full wage-and-hour audit that can result in an unplanned financial burden. Employers should be careful to correctly apply the criteria associated with exempt status under the FLSA. 2

4 MISTAKE 3: POOR RECORDKEEPING Given the challenges every business owner faces every day, it s understandable that maintaining records is often low on the priority list. Records of taxes, income, and receipts are often missing or disorganized. Ultimately, these records are vital to create accurate tax forms for the IRS and state agencies and may be very time consuming to gather. To save time and frustration in the long run, business owners should be keeping meticulous records of payments, disbursements, tax payments, and employee tips. Outsourced payroll services and/or software, along with an employee time and attendance system such as time clocks, can help to automate recordkeeping tasks, increase accuracy, and save time. A single mistake, even one as simple as transposing digits or using the wrong tax identification (ID) on tax forms and payments, can result in fines and countless hours to correct the problem. MISTAKE 4: WRONG IDS AND FREQUENCY A single mistake, even one as simple as transposing digits or using the wrong tax identification (ID) on tax forms and payments, can result in fines and countless hours to correct the problem. Each business must have an assigned ID number. Employers without valid ID numbers should contact federal, state, and local agencies because sending returns or payments without an ID can result in delays in posting account information and associated penalties. Businesses assigned multiple IDs must take care to use the correct one. MISTAKE 5: SPECIALTY INDUSTRIES Different industries often have different rules, laws, tax forms, and even tax credits. In payroll, there isn t a one-size-fits-all rule, and often, an entrepreneur will switch industries or hire an administrative employee from another industry who isn t necessarily familiar with the differences in tax rules. For instance, restaurant owners should be familiar with TEFRA (Tax Equity and Fiscal Responsibility Act of 1982). TEFRA, enacted in part to ensure that cash tips are accurately reported, requires IRS Form 8027 to report tips to the government. In addition, many restaurant owners aren t aware of the FICA Tip Credit, which allows an owner to possibly recover a portion of the payroll taxes paid on tipped employees. MISTAKE 6: GARNISHMENTS AND CHILD SUPPORT Wage garnishment kicks in when a court order requires an employer to withhold a portion of an employee s earnings for the payment of a debt. Title III of the Consumer Credit Protection Act prohibits an employer from discharging employees because their earnings have been subject to garnishment for any one debt, regardless of the number of levies made or proceedings brought to collect it. Employers must always include the employee case number with garnishment payments. This simple component of conscientious recordkeeping makes the posting process much more efficient for the 3

5 garnishing agency and may save the employer from the possibility of delinquency notices. Employers must also be mindful of federal and state new-hire requirements. New-hire reporting is the process by which an employer reports information about newly hired employees to a designated state agency shortly after the date of hire. New-hire reports are matched against child support records at the state and national levels to locate parents who owe child support monies. This is especially helpful for interstate cases (in which one parent lives in a different state from the child), which are often the most difficult cases for states to resolve. With new hire-reporting, state child support enforcement agencies can issue income-withholding orders, the most effective means of collecting child support in a timely fashion. Even though an employee on long-term disability is receiving salary payments from a third-party insurance provider, employers still must fulfill tax-filing requirements on the employee s wages. This responsibility can catch an employer unaware. MISTAKE 7: THIRD-PARTY SICK PAY Even though an employee on long-term disability is receiving insurance benefits from a third-party insurance provider, employers must still fulfill tax-filing requirements on the employee s wages. This responsibility can catch an employer unaware. The third party must report disability payments on Form W-2 for employees paid sick pay if the third party: is paid an insurance premium and is not reimbursed on a cost-plusfee basis; or is designated as the employer for sick payments based upon an agreement; or fails to: withhold the employee s share of Social Security and Medicare taxes and deposit them when due; notify the employer of the disability payments made and taxes withheld so the employer can file proper returns (i.e., in time to file Form 941 tax returns quarterly with the IRS); and provide the employer with information about sick payments made by January 15 of the following year to enable the employer to prepare employee W-2s showing sick-pay amounts. More information about sick pay can be found in IRS Publication 15-A, Employer s Supplemental Tax Guide. MISTAKE 8: FRINGE BENEFITS In general, taxable fringe benefits are reported when received by the employee and are included in employee wages in the year they are received. Although fringe benefits are easily disregarded as incidental events, employers must identify and report them correctly. The IRS looks closely at how employers interpret this type of compensation. 4

6 The following are common fringe benefits. Health savings accounts and cafeteria plans Dependent care expenses Company-provided car De minimis items (about minimal things) Education assistance Employee discounts for property or services Employee stock purchase plans Free parking (employer-paid) Group-term life insurance Incentive stock options Interest-free or bargain-rate loans Meals and lodging Medical and dental coverage No-additional-cost services Outplacement services Employer-provided retirement plans Stock bonuses or bargain purchases Transit passes Working-condition benefits Employers must comply with the FLSA as well as applicable state regulations to ensure appropriate classification of exempt employees; a single mistake can initiate a full wage and hour audit at either the federal or state level. Some may not be taxable, are taxable above certain thresholds, or are taxable under specific circumstances. See IRS Publication 15-B (2011), Employer s Tax Guide to Fringe Benefits, for details. MISTAKE 9: OVERTIME RULES Employers are required to compensate non-exempt employees with the appropriate premium pay for all overtime work, regardless of whether the overtime was authorized. Employees covered by the Fair Labor Standards Act must receive overtime pay for hours worked in excess of 40 in a workweek of at least one and one-half times their regular rate of pay. The FLSA does not require overtime pay for work on Saturdays, Sundays, holidays, or regular days of rest, unless overtime hours are worked on such days. State laws may vary. Company policy or collective-bargaining agreements may be more generous with regard to overtime payments. The FLSA does not specifically require premium or double-time pay for hours worked on weekends or night shifts, although company policy or a collective-bargaining agreement may. Employers must comply with the FLSA as well as applicable state regulations to ensure appropriate classification of exempt employees; a single mistake can initiate a full wage and hour audit at either the federal or state level. MISTAKE 10: TAX DEPOSITS Penalties can add up when the IRS finds missed payments in the lookback period. In addition, tax payments may be due annually or within a few days of a payroll, depending on the type of tax and size of business. As businesses grow, owners sometimes aren t aware of the effects their new size may have on tax frequency, resulting in late payments and penalties. 5

7 CONCLUSION Mastering Payroll Compliance: The Top 10 Mistakes That Cost Employers Money A squeaky-clean record with tax agencies reinforces a company s reputation in the community and with employees, vendors, and creditors much like a credit score. Both employers well versed in tax, employment, and benefits guidelines and those who outsource payroll and accounting and consult legal advisors may avoid costly penalties and inconvenience. 6

8 ABOUT PAYCHEX Paychex, Inc. (NASDAQ:PAYX) is a leading provider of payroll, human resource, and benefits outsourcing solutions for small- to mediumsized businesses. The company offers comprehensive payroll services, including payroll processing, payroll tax administration, and employee pay services, including direct deposit, check signing, and Readychex. Human resource services include 401(k) plan recordkeeping, section 125 plans, a professional employer organization, time and attendance solutions, and other administrative services for business. A variety of business insurance products, including group health and workers compensation, are made available through Paychex Insurance Agency, Inc. Paychex was founded in With headquarters in Rochester, New York, the company has more than 100 offices serving approximately 567,000 payroll clients as of May 31, For more information about Paychex and our products, visit The information in this paper is furnished for informational use only and should not be construed as a commitment by Paychex, Inc. Paychex provides such information as a service and is not implying its endorsement of, or agreement with, such opinions, information, analyses, recommendations, or conclusions. If legal advice or other expert assistance is required, the services of a competent professional should be sought. 2012, Paychex, Inc. Paychex, Inc., 911 Panorama Trail South Rochester, New York

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