Employers are responsible for payroll taxes whether they have one employee or one hundred. Withholding federal and state income taxes, FICA taxes, paying the employer share of FICA tax and federal and state unemployment taxes is a big responsibility with financial and legal penalties for mistakes and noncompliance. Don’t make the following common payroll tax mistakes with your payroll.
Mistake #1: Incorrect Employee Classification
When someone provides services for your company, their employment status is dependent upon the business relationship between the company and the person performing services. Employers must withhold and pay income taxes, Social Security and Medicare taxes, and pay unemployment tax on employee wages, while companies do not withhold or pay taxes on payments made to independent contractors. An employer is required to furnish a W-2 to any employee with any amount of earnings in the year, while they are only responsible for issuing a Form 1099-MISC to independent contractors to those who have been paid $600 or more in the year.
Although independent contractors are less costly and significantly less complicated for employers, the independent contractor classification has a very specific definition that must be proven if there is any question or claim that the IRS investigates. Properly classifying employees and independent contractors depends on many “tests,” including the amount of control over and direction to the worker, or being able to say where, when, and how the work is done.
Employers should make sure they understand the IRS rules for worker classification, consult an HR and tax advisor with any questions, and file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding if they cannot make a determination between independent contractor and employee on their own.
Mistake #2: Not Keeping Payroll Records
Creating and maintaining payroll records is required by the IRS and Federal and State Department of Labors. Records that must be retained include time sheets, expense reports, W-2 history, and other payroll records in case of an IRS or DOL audit. These records should be retained for at least six years.
I-9 Forms, or verification of employment eligibility, should also be kept on file, and must be kept for three years from the date of hire or one year from the termination of employment, whichever date is later. Violations go beyond simple retention, so forms should be carefully examined for accuracy, as fines and penalties for I-9 violations can run from $1100 for noncompliance to $6500 for document fraud. I-9 forms can be completed and maintained via paper, microfilm, microfiche, or electronic method. A self-audit or third-party audit performed on a regular basis will help identify liability and noncompliance proactively before an issue arises with a government agency.
Mistake #3: Paying Creditors before the IRS
As a business owner operating a business, there may be times funds and resources are limited and you have to choose between paying a vendor or utility and paying the IRS. While this can be a difficult decision, it is important to ensure your payroll taxes are paid on time. Set aside enough funds to cover payroll taxes so you can always be sure your payroll taxes are able to be remitted timely.
When you use an online payroll service, they will compute your payroll tax liability and collect it ahead of the due date so it’s available when they need to pay it. If you do not have enough funds to cover your payroll service’s debit, the payroll taxes will not be paid until you submit those funds to the payroll service. Do this as soon as feasibly possible to meet your employer responsibilities and avoid any penalties or entanglements with the IRS or state agencies. Civil fines, criminal penalties, and court orders for unpaid taxes are just a few of the consequences when a company doesn’t pay close attention to payroll taxes. A few late payments to tax agencies can cripple a business, as penalties and interest can eventually cause a bank account to be levied.