Payroll may seem straightforward: the employees work, you cut a paycheck, and everyone goes home happy. But that’s not always the case.
When Tesco upgraded its payroll system, they never imagined it would lead to a massive underpayment issue. A calculation error caused by staff voluntary wage contributions left around 140,000 employees receiving less than the minimum wage. The company now faces a hefty bill, having to pay back nearly 10 million pounds in wages to their affected workforce.
Then there’s the Department of Corrections in Wisconsin, which found itself asking employees to pay back over $39,000 after discovering overpayments. While employees were initially paid what they were told, the department later determined these payments were made in error. The situation now leaves both parties dealing with the fallout of an avoidable mistake.
Mistakes like these can happen to any business, big or small. And the truth is that even companies with the most organized processes can fall prey to payroll mishaps.
In this blog, we’ll discuss common payroll mistakes that can cost you big time and how to avoid them.
1- Missclassifying employees or subcontractors
At first glance, it can seem simple: contractors work independently, employees work for you. But classification rules are not that straightforward.
The IRS and Department of Labor look at things like how much control you have over the work, who provides the tools, and how the worker is paid. If you treat someone like a contractor but manage their hours, direct their tasks, and supply everything they need, there’s a good chance they’re actually an employee in the eyes of the law.
The modern workforce, with freelancers, remote workers, and part-timers, only makes this trickier. For example,
- A remote worker might look like a contractor but legally be an employee (because you control their work hours and methods).
- A part-timer might need benefits depending on their hours and your state’s laws.
- Freelancers who work only for you and follow your directions might actually be classified as employees.
To avoid this mistake when handling bookkeeping and payroll, you must check the IRS 20-factor test to determine if someone is an employee or an independent contractor. Employers are also required to follow the DOL guidelines under the Fair Labor Standards Act (FLSA), which focuses heavily on who controls the work.
Also read: 1099 vs. W-2 forms: What’s the difference for employers?
2- Confusing gross pay with net pay
You think paying someone $2,000 means writing them a $2,000 check? Not quite.
Gross pay is what an employee earns before deductions. Net pay is what they take home after taxes, benefits, and withholdings. Confusing the two means either underpaying staff or overpaying taxes.
Some common mistakes that business owners make are:
- Forgetting to factor in pre-tax benefits like health insurance or retirement contributions.
- Withholding too little (or too much) in federal, state, or local taxes.
- Ignoring wage garnishments or court-ordered deductions.
These minor slip-ups can cause payroll disputes, tax penalties, and strained employee trust. So, always double-check your math before hitting “submit”.
3- Overlooking overtime regulations
In 2022, Google found itself in hot waters. A group of workers filed a lawsuit claiming Google allegedly miscalculated overtime pay by excluding commission and stock unit payments from workers’ regular rates.
It was a simple but costly mistake.
The loss? Nearly $8.4 million. The company had to pay back wages, legal fees, and deal with reputational fallout.
The worst part? This wasn’t a one-time glitch. Back in 2018, Google and a staffing agency paid $5.5 million to settle a case involving recruiters and sourcing professionals who claimed they were forced to work overtime without proper compensation.
If tech giangts like Google can overlook something as basic as properly calculating overtime, your bookkeeping and payroll services can too. For non-exempt employees, you must include all forms of compensation, like commissions, bonuses, and stock units, in the regular rate when calculating overtime. Overlooking these details can easily lead to underpaying workers for the hours they worked.
4- Maintaining poor bookkeeping records
Missing forms like W-4s and W-9s, or failing to issue 1099s for contractors are paperwork errors that can lead to incorrect tax withholding and misreported wages.
If you don’t track employee hours accurately or forget to update tax forms, you might pay the price in back taxes, interest, or worse, audits. Imagine being asked for records you can’t find or realizing they’re incomplete. That’s a recipe for a costly audit, bookkeeping and payroll penalties, and potential lawsuits.
5- Using an inefficient payroll system
When payroll is delayed or missed altogether, the consequences go beyond frustrated employees. It can lead to legal issues, reputational damage, and even fines for your business.
The Wage and Hour Division (WHD) of the US Department of Labor is actively addressing such issues nationwide. In 2024 alone, they recovered more than $273 million in back wages and damages for nearly 152,000 workers. That’s a massive impact and a clear reminder that employers are under scrutiny. If your payroll isn’t on time or if employees aren’t paid correctly, you could end up in a similar situation.
6- Making payroll tax mistakes
Payroll taxes are critical for your business’s financial obligations, and failing to pay them correctly can have severe consequences. From minor mistakes to outright tax evasion, these errors can result in fines, penalties, and even prison sentences.
Take Jonathan Louis Lepow, for example. As the manager of a Houston dental clinic, he failed to pay $544,272 in trust fund taxes between 2015 and 2017. Lepow’s actions led to a federal investigation, and now he could face five years in prison and a $250,000 fine.
Yes, this was intentional tax evasion. But here’s the thing: even unintentional mistakes can lead to trouble. Misclassifying wages, miscalculating withholding, forgetting to file forms like 941s, or missing tax deposit deadlines might not be criminal, but they still trigger penalties, interest, and IRS audits.
The solution? Keep your records straight with bookkeeping and payroll services. That means accurate records, timely filings, and a system that catches mistakes before they cost you.
The bottom line
Between juggling client deadlines, onboarding new hires, and tracking expenses, even the most capable small business owners can overlook payroll details like tax deadlines, correct forms, or payment calculations.
So, how do you avoid these mistakes and the costly consequences that follow? Certainly not by adding more to your already full plate and diving into IRS manuals or your payroll system late at night. Instead, work smarter and hand off your payroll to experts who know exactly what to look for, what to file, and when to act.
That’s exactly what we do at CoCountant.
With us, you get bookkeeping and payroll services that catch what busy business owners often miss, like a forgotten W-9, a mistimed pay run, or an incorrect tax rate buried deep in your software settings.
That means tracking every expense, logging every billable hour, and making sure your payroll entries match your general ledger, down to the cent. From real-time payroll syncing and tax filings to audit-ready reports and clean financial records, we ensure your books are acurate and your payroll compliant.
FAQs
Is outsourcing payroll worth it for a small business?
Yes, outsourcing can reduce errors, improve compliance, and free up time, especially for businesses with limited internal resources.
What’s the difference between a payroll service provider and a PEO?
A payroll provider handles payments and tax filings. A PEO also co-employs workers and manages HR functions, benefits, and compliance.
How do I correct a payroll error after it’s already been processed?
Act quickly. Notify your employee, adjust the next paycheck or issue a correction payment, and update your records and tax filings accordingly.
