Paying payroll taxes is a lot more complicated than applying a tax rate and sending payments to the federal government. It involves navigating federal, state, and sometimes local rules, classifying workers, and knowing which tax rate to apply at the right time.
Many businesses—especially small- to medium-sized companies without an in-house tax department—might pay hefty fines and penalties due to unintentional errors. To help you the same fate, here are some of the most common mistakes business owners make when paying payroll taxes.
You must ensure your workers are correctly classified before you cut a single paycheck or withhold a cent of payroll taxes.
Each worker can be categorized in one of two main categories: employee vs. independent contractor. You can further classify employees into exempt or non-exempt, as per the Fair Labor Standards Act (FLSA).
These classifications aren't straightforward for many businesses. However, the Department of Labor (DOL) has a variety of resources to help you determine whether your workers are employees or independent contractors, exempt or non-exempt, based on factors like how they're paid, whether they provide their own equipment, and who decides when and how they'll perform the work.
For the 2021 fiscal year, the DOL collected over $230 million in back wages that companies owed to workers.
If you pay employees less than minimum wages, make employees work while off the clock, or refuse to pay overtime rates, you could find yourself the target of a DOL investigation.
Don't wait for a summons or official notice to correct past mistakes. Instead, make sure you're paying the right amount to workers, as it can also impact the amount of payroll taxes you withhold and pay.
Improperly withholding taxes on bonuses and overtime
When you pay bonuses and overtime, don't assume you can just apply the same tax rate.
The IRS considers bonus payments supplemental wages and should have federal income taxes withheld at a flat 22% rate. Overtime isn't subject to a special tax rate. However, if employees work a lot of overtime, it could bump them into a higher tax bracket. For these reasons, you should exercise special care when calculating taxes on bonuses and overtime.
Many businesses make the mistake of using the same withholding rate on these types of payments, which can stick employees with a big tax bill—likely not the kind of employee experience you want to create for your talented and hard-working team.
Applying the wrong state tax rates
A significant aspect of paying payroll taxes involves state income taxes. Unfortunately, every state has different rates and rules, making it difficult for businesses with employees spread across several jurisdictions.
The COVID-19 pandemic exacerbated the issue. When companies were forced to close their offices and send employees to work from home, where did those employees go? It's not uncommon to discover that an employee hasn't been working from a home office across town but from a friend or relative's home or vacation home out of state, and the company has been withholding taxes for the wrong state as a result.
Each state has its own rules for how long an employee must be working from the state before withholding is required. That's why companies must know where employees are located, familiarize themselves with the laws in each state, and withhold the right taxes.
Handling payroll in-house
When processing payroll and paying payroll taxes, taking the DIY route is risky for small- to medium-sized businesses.
Handling payroll on your own might initially be less expensive than outsourcing it to an accountant or payroll provider. But fines and penalties related to misclassified workers, underpaid wages, and inaccurate withholding make it much more costly in the long run.
Payroll processing and tax withholding is a specialized task requiring awareness of the latest change in federal and state laws. If your in-house team doesn't have expertise in this area, outsourcing payroll to a qualified professional can save you time, stress, and money.