Growing Complexity of Payroll Regulations Contributes to Errors 

Key Takeaways: 
  • Payroll mistakes can result in fines and penalties that can slowly drain a business.
  • Late filing, worker misclassification and overtime rules are the most frequent problem areas. 
  • Outsourcing payroll can save time and money. 

 

Payroll mistakes aren’t just irritating, they are also frequently costly because they expose employers to fines and penalties that can slowly drain a business. The complexity of federal and state payroll regulations and deadlines make payroll a particularly vulnerable area for employers, especially smaller businesses that try to do the payroll themselves.  

The payroll errors that cost business owners the most money fall into several predictable categories listed below. If any of these feel familiar to you, consider outsourcing your payroll so you can focus on your core business. 

Paying or Filing Payroll Taxes Late 

To put payroll taxes into context, one should remember that a portion are trust fund taxes, not business taxes. These are taxes that are owed by your employees, and you are entrusted with the responsibility to withhold the funds and deposit the proper amounts on your employees’ behalf. They are called trust fund taxes because they are held in trust until they are paid to the U.S. Treasury, and your employees trust that you will pay the withholding to the Treasury by making federal tax deposits. Businesses that fail to withhold these taxes from their employees’ pay, file the related returns or make the necessary deposits risk major penalties that can shut a company down. 

In some businesses, wage amounts may change frequently, which means the amount of payroll taxes also change. For businesses that do their payroll in-house, updating these numbers takes time and may result in a late filing and payment. Moreover, payroll taxes must be paid to the federal, state and local governments, which may have different deadlines, and there are many different due dates. Some payroll taxes are paid semi-weekly and others monthly or quarterly, and if your payroll tax liability is over $100,000, it must be filed and paid the day after the payroll is made. That’s a lot to remember for a person who is running a business. 

Some business owners are surprised to learn they must file payroll tax returns even if they had no payroll during a certain period. Failure to file results in penalties, and in Kansas an employer who fails to file a “zero return” will find that the state has estimated their liability based on the highest monthly payroll they have paid in the past. 

Misclassifying Workers as Contractors  

Worker classification rules are protocols determined by the IRS and U.S. Department of Labor (DOL) that govern the distinction between employees, who are on a company’s payroll, and independent contractors, who are not on payroll but are paid to perform specific functions that companies often need.  

Employers often prefer to pay a worker as a contractor because it relieves the company of the obligation to withhold payroll taxes, offer employee benefits and comply with certain workplace laws for contractors. However, federal and state rules strictly govern when a worker can be treated as a contractor and when they must be treated as an employee.  

Misclassifying a worker as a contractor by not making proper withholdings from their pay can result in state or federal audits of your payroll tax returns and significant financial penalties. In cases where the IRS or DOL reclassifies independent contractors to employees, the employer will need to cover any under withheld taxes, including the full 15% of FICA taxes. There would also be additional penalties and interest charged for misclassifying workers.  

Overtime and Wage/Hour Rules 

Employers who want to avoid paying overtime will sometimes misclassify an employee as “exempt.”  

Under the federal Fair Labor Standards Act (FLSA) exemption generally only applies to employees who hold professional roles that require a higher level of expertise and knowledge. This might include executives, professionals who hold degrees or certifications, administrators and management personnel. The FLSA also sets minimum salary standards for exempt employees, so employers cannot simply state that a restaurant cook is a “kitchen manager.” 

Additional Common Payroll  Mistakes 

In addition to the major areas listed above, businesses commonly make the following missteps: 

  • Not updating their records and procedures to account for new laws – The 2026 tax season will be the first time employers will have to provide information to their employees that will be necessary for them to claim the new federal overtime and tip income deduction. Additionally, state family leave laws frequently change, as do minimum wage laws. Make sure you know what to do to comply with these changes. 
  • Not communicating with benefit providers when employees leave the company – Terminated employees must be removed from benefit roles, just as new employees are added. Make sure your records are up to date and you have communicated personnel changes to the benefit providers. 
  • Failure to review payroll reports from outsourced payroll providers – Reviewing these reports can help identify areas where your record keeping needs improvement, as well as correct any errors. 
  • Underreporting payroll or misclassifying workers on your workers’ compensation account – Leaving off 1099 contractors, misclassifying the nature of their work and not verifying coverage for 1099 workers are common mistakes. The company can be hit by a penalty from the insurance company if they discover you weren’t reporting 1099 workers, or you reported them as performing less dangerous work than they are actually performing. 

What Happens if you Make a Mistake 

Penalties and interest can be steep for even a simple mistake on payroll tax preparation, and they rise significantly if the IRS determines that the misreporting was intentional. If you are more than 15 days late with a federal filing, the fine stands at 10% and increases to 15% quickly. Moreover, once the IRS has determined your payroll tax filings are problematic, they can audit your returns going back several years. You could be liable for penalties on wages you paid years ago, and you could be required to pay both the government and the affected employees for those past mistakes. 

Additionally, if the DOL determines that you purposefully did not properly pay overtime when it was due, the penalties can be doubled due to a willful violation. 

Questions? 

With increasing rules around wages, benefit plans and taxes at the federal and state levels, payroll is becoming more and more complex every year. And it requires more hours of preparation than a business owner or a single finance employee can devote.  

Working with an outsourced payroll provider can save time and money. If you would like to discuss your company’s payroll needs, contact an Adams Brown payroll advisor.