Payroll administration can be challenging for small business owners. Even minor mistakes can result in incorrect paychecks, frustrated employees and time-consuming corrections. Errors involving tax withholding, deposits or reporting may also expose your business to interest and penalties.

Payroll software and third-party providers can simplify the process, but they don’t eliminate your responsibility as an employer. The following steps can help your business avoid common payroll tax mistakes and respond appropriately when errors occur.

Withhold and Deposit Payroll Taxes Correctly

Employers generally must withhold federal income tax and the employees’ share of Social Security and Medicare taxes from wages. Employers are also responsible for paying their share of Social Security and Medicare taxes.

These amounts must be deposited with the IRS and reported on the appropriate employment tax returns. Additional requirements may apply to:

• The 0.9% Additional Medicare Tax
• Federal unemployment tax
• State and local payroll taxes

The IRS provides detailed withholding, depositing and reporting requirements in Publication 15, Employer’s Tax Guide.

Review Employee Withholding Information

Errors when entering information from an employee’s Form W-4, “Employee’s Withholding Certificate,” can lead to incorrect federal income tax withholding. Changes involving an employee’s name, address or immigration status may also create payroll reporting issues.

Establish a consistent process for reviewing employee information when someone is hired or submits an updated Form W-4. Employees can use the IRS Tax Withholding Estimator to evaluate their federal income tax withholding.

Monitor Federal Tax Deposit Deadlines

One of the most serious payroll mistakes is failing to deposit federal income tax, Social Security and Medicare taxes on time. IRS failure-to-deposit penalties generally increase based on how late the payment is:

• One to five calendar days late: 2% of the unpaid deposit
• Six to 15 calendar days late: 5% of the unpaid deposit
• More than 15 calendar days late: 10% of the unpaid deposit

The penalty may increase to 15% when payment remains unpaid after certain IRS notices or demands for immediate payment.

If the IRS determines that a responsible person willfully failed to collect or pay withheld taxes, a Trust Fund Recovery Penalty may apply. This penalty can equal the unpaid trust fund tax and may be assessed personally against responsible individuals within the organization. Learn more from the IRS about employment taxes and the Trust Fund Recovery Penalty.

To reduce your risk:

• Establish procedures for monitoring deposit deadlines.
• Regularly reconcile payroll records with amounts reported and deposited.
• Investigate discrepancies promptly.
• Confirm that payroll tax returns have been filed on time.
• Maintain documentation supporting each deposit and filing.

Even when your business uses an outside payroll provider, it generally remains responsible for ensuring that federal taxes are paid and employment tax returns are filed on time.

Report All Forms of Taxable Compensation

Salary and hourly wages aren’t the only forms of compensation that may need to be included in an employee’s taxable income. Employers may also need to report:

• Bonuses
• Awards and prizes
• Taxable fringe benefits
• Certain employer-provided allowances
• Other noncash compensation

Failing to include taxable compensation can result in insufficient withholding and payroll tax deposits. It may also expose an employer to information-return penalties for filing an incorrect Form W-2, “Wage and Tax Statement.”

Review Benefits Before Processing Payroll

Evaluate the tax treatment of bonuses, awards and fringe benefits before entering them into your payroll system. This review is especially important when introducing a new benefit or revising a compensation arrangement because the rules for federal income tax withholding, Social Security taxes and Medicare taxes may differ.

The IRS provides additional information about taxable and nontaxable benefits in Publication 15-B, Employer’s Tax Guide to Fringe Benefits.

Businesses that need additional assistance managing payroll records, reconciliations and financial reporting may also benefit from THF’s outsourced accounting services.

Correct Payroll Tax Mistakes Promptly

Despite strong procedures, payroll mistakes can still happen. When you discover an error, begin by determining:

• What went wrong
• Which employees were affected
• Which payroll periods were affected
• Whether the error involves taxable wages, withholding, deposits or information reporting

Once you understand the scope of the problem, identify the appropriate correction procedure. Acting quickly is important because the available options may depend on when the error is discovered.

Use the Appropriate Correction Form

Depending on the mistake, your business may need to:

• Adjust an employee’s pay
• Correct internal payroll records
• Make an additional payroll tax deposit
• Amend a previously filed employment tax return
• Issue a corrected wage statement

Certain errors reported on Form 941, “Employer’s Quarterly Federal Tax Return,” may need to be corrected using Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund.

An incorrect Form W-2 may require Form W-2c, “Corrected Wage and Tax Statement.” Employers can review the Social Security Administration’s guidance for correcting Forms W-2 and W-3 before submitting corrected information.

Document the Error and Communicate With Employees

Maintain records that explain:

• The nature and cause of the error
• The employees and payroll periods affected
• The calculations used to determine the correction
• Any additional tax deposits made
• The forms filed to correct the issue
• Communications provided to affected employees

If an employee’s pay or tax information changes, communicate promptly so the employee understands what happened and whether any action is required.

Strengthen Your Payroll Tax Compliance Procedures

Strong review procedures can reduce the likelihood of payroll errors, while prompt action can limit the financial and operational impact when mistakes occur.

Consider implementing these payroll controls:

• Use a payroll processing checklist.
• Assign responsibility for reviewing payroll before submission.
• Track federal, state and local filing deadlines.
• Reconcile payroll reports with tax deposits and general ledger accounts.
• Review employee information regularly.
• Evaluate the tax treatment of new benefits before implementation.
• Periodically assess the performance of third-party payroll providers.

THF’s business accounting services can help your organization strengthen its accounting processes and maintain accurate financial records.

Keep Your Payroll on Track

Payroll tax mistakes can be costly, but your business doesn’t have to manage complex compliance requirements alone. If you discover a payroll error or have questions about withholding, deposits, reporting or correction procedures, THF can help you understand the applicable requirements and strengthen your payroll practices.

Contact the THF team today to discuss your payroll tax and accounting needs.