Common payroll mistakes in HR systems

 

Error #1: Misclassifying Employees

One of the most frequent and costly payroll errors is the misclassification of workers. This typically occurs in two ways: misclassifying a non-exempt employee as exempt from overtime, or misclassifying an employee as an independent contractor. Both mistakes carry substantial risks.

The Problem: Exempt vs. Non-Exempt Status

Under the Fair Labor Standards Act (FLSA), employees are categorized as either "exempt" or "non-exempt." Non-exempt employees are entitled to overtime pay (at least 1.5 times their regular rate) for any hours worked over 40 in a workweek. Exempt employees, who must meet specific salary and duties tests, are not.

The error occurs when an employer incorrectly labels an employee as exempt, often based on their salaried status alone. However, being paid a salary does not automatically make an employee exempt. They must also perform specific job duties that fall under administrative, professional, executive, or other defined exemptions. A misclassification can lead to years of unpaid overtime, which a company may be forced to pay back with damages.

The Problem: Employee vs. Independent Contractor

Another common pitfall is classifying a worker as an independent contractor when they should be treated as an employee (W-2). Businesses might do this to avoid paying payroll taxes, unemployment insurance, and workers' compensation, or providing benefits. The IRS and Department of Labor (DOL) look at this issue very closely, using a multi-factor test to determine the degree of control a company has over the worker. If the company controls what work is done and how it is done, the worker is likely an employee.

Error #2: Incorrect Tax Withholding and Filing

Payroll tax laws are notoriously complex and are a major source of errors. Mistakes can range from withholding the wrong amount from an employee's paycheck to failing to deposit taxes on time with government agencies.

The Problem: Withholding and Deposit Errors

Employers are responsible for withholding federal income tax, Social Security, and Medicare (FICA) taxes from employee wages. Many states and localities also have their own income taxes. An error can occur if the employee's Form W-4 is processed incorrectly or if outdated tax tables are used.

Furthermore, these withheld taxes, along with the employer's share of FICA and unemployment taxes, must be deposited with the appropriate agencies according to a strict schedule. Missing a deposit deadline, even by one day, can trigger automatic penalties and interest from the IRS.

The Problem: Inaccurate Year-End Reporting

At the end of the year, employers must provide each employee with a Form W-2, Wage and Tax Statement, which reports their annual wages and the amount of taxes withheld. An error on the W-2—such as incorrect wage information or a misspelled name—can create significant problems for employees when they file their personal tax returns. The data on W-2s must also match the information filed with the Social Security Administration, and discrepancies can trigger an audit.

Error #3: Mishandling Overtime Pay

Overtime calculation errors are one of the most common reasons for wage and hour lawsuits. The FLSA has very specific rules about who is entitled to overtime and how it must be calculated, and mistakes are easy to make without proper training.

The Problem: Calculating the Regular Rate of Pay

For non-exempt employees, overtime must be paid at 1.5 times their "regular rate of pay." A common error is assuming the regular rate is simply the employee's hourly wage. However, the regular rate must include all compensation, such as non-discretionary bonuses, commissions, and shift differentials. Failing to include these additional payments in the overtime calculation results in underpayment.

The Problem: Tracking Off-the-Clock Work

In today's connected world, it's easy for non-exempt employees to perform work outside of their scheduled hours, such as answering emails from home or taking calls during their lunch break. If a company knows or has reason to believe a non-exempt employee is working, that time must be paid. Many employers fail to track and compensate for this "off-the-clock" work, leading to major FLSA violations.

 Common payroll mistakes in HR systems