10 Payroll Issues for Small Businesses

You may not think of your small business's payroll function as risky. But if you don't properly handle certain payroll challenges, you may risk IRS scrutiny, operational disruptions, and financial losses. What should you watch out for? Here's a list of 10 payroll issues small organizations must grapple with.

1. Accurate recordkeeping

If you don't keep detailed and accurate records, it will probably come back to haunt you. For example, the Fair Labor Standards Act (FLSA) requires businesses to maintain records of employee earnings for at least three years. And FLSA violations can result in severe penalties. Although some of your employees may be conscientious recordkeepers, you need to ensure they know exactly what records to keep.

2. Worker misclassifications

One of the biggest potential obstacles facing small businesses is worker misclassification. If you classify a worker as an independent contractor when that person should be classified as an employee, the IRS could intervene. Violating classification rules can result in your company owing back taxes and penalties, plus it may have to restore expensive fringe benefits. The rules can be confusing, so discuss challenging cases with your tax advisor.

3. Manual activities

Manual payroll processes often are time-consuming and can lead to inaccuracies. Payroll software is widely available, relatively inexpensive, and generally easy to use. These programs complete tasks faster and typically reduce error rates. So, use automated processes whenever possible.

4. Privacy concerns

Given the prevalence of cybercrime, you have an obligation to protect the private information of employees from potential hackers. Obviously, you can't operate payroll without data such as the Social Security numbers, home addresses, dates of birth, and bank account numbers of workers. Invest in effective data protection software and ensure that only those payroll employees who need access to personal information know the password.

5. Fraud threats

Occupational (or internal) fraud remains a major threat to small businesses. Schemes can range from "cheating" on timesheets by rank-and-file workers to embezzlement by executives. The first and best way to protect your accounting department and payroll function from fraud is to require the segregation of duties — meaning no one person receives, records, and deposits payments, pays bills, prepares payroll, and reconciles bank statements. If you don't have enough employees to segregate duties, consider outsourcing some or all these activities.

6. Legal compliance

Face it — if you're not an attorney, CPA, or payroll consultant, you're probably not current on the latest regulatory payroll developments affecting your business. Laws and regulations are constantly evolving, and failing to stay abreast of changes could cost you money. So be sure to work with knowledgeable, experienced advisors.

7. Tax compliance

Employers are responsible for calculating tax withholding on employee wages. In addition to deducting federal payroll tax from paychecks, your organization must fork over its own share of payroll tax. If you get it wrong, the IRS could investigate, triggering additional tax liability and penalties. In general, an automated payroll tax system will reduce the likelihood of withholding errors.

8. Technology integration

Your payroll software doesn't exist in a vacuum. This technology should be integrated with other systems to maximize benefits. Because manual integration of different software can be difficult, you may want to use a suite of applications or connect via interfaces that transfer data in real-time. If you don't have the expertise on staff, engage a technology consultant.

9. Back up data

Even if your network security system is strong, no system is invulnerable. Regularly back up payroll data in the event it's compromised. Using the cloud for day-to-day data backup is generally a good idea, but you might also want to keep a backup of your payroll system in a different physical location.

10. Employee changes

As many companies shift to permanent remote work, their employees may physically move. Make sure any home address and other personal information changes are promptly entered into your payroll system. This is particularly important if employees move to a different state and will be subject to different tax rates and rules.

These are only 10 of the payroll challenges that face small businesses. But there may be others that are specific to your industry, size, or business model. Contact a tax professional to discuss other potential issues.

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