As soon as you hire your first employee, the challenges of payroll management begin. The technicalities and need for vigilance increase exponentially as your company grows and its workforce expands. Even if you downsize staff and turn more toward independent contractors, considerable payroll-related issues should be considered.
What’s a business owner to do? To stay apprised of payroll management’s risks to the ongoing stability of your company, keep your eye on the following four fundamentals. Succeed in these spheres and you’ll stand a better chance of heading off mistakes or oversights before they turn into major crises.
1. Understand the process
Many businesses outsource their payroll functions to external providers. This is a perfectly reasonable way to reduce time, effort and money spent on payroll administration. In addition, providers may have better technology and offer additional services related to regulatory compliance.
The use of a payroll services provider doesn’t absolve an employer of its responsibility for payroll taxes. Miscommunications, mistakes and, in rare cases, even intentional wrongdoings can occur. So, even when outsourcing, you need to understand your company’s distinctive requirements and processes for tracking, administering and recording payroll.
It’s also a good idea to monitor your payroll tax account to verify funds are being deposited in a timely fashion and in accurate amounts. If you’re using electronic deposits, the federal government’s EFTPS website (https://www.eftps.gov/eftps) can enable you to observe your account’s activities.
2. Know what’s taxable
Another fundamental to guarding against payroll risk is simply knowing what’s taxable and what’s not — and keeping up with these items from year to year. So, what is taxable? “Wages” of course, but the law defines this word broadly to include many types of compensation, including full- and part-time salaries, hourly wages, fees, bonuses, and commissions.
It’s also helpful to look into what’s generally not subject to payroll taxes under the Internal Revenue Code. Some noncash compensation may be deemed a “statutorily excluded” (or “fringe”) benefit and, therefore, excluded from employee income.
Examples include group term-life insurance (up to certain limits), some health care coverage and parking privileges. In fact, one potential way to ease your payroll tax burden is to compensate employees partially in the form of such benefits rather than wages.
Another way to reduce your payroll tax burden is to create an accountable plan to reimburse employees for the costs of travel, entertainment, tools or other eligible business-related expenses.
As long as the plan meets IRS standards to qualify for tax-advantaged treatment, you won’t have to pay employment taxes on the reimbursements, and your employees won’t have to pay income taxes or their portion of employment taxes on them either. Plus, you can deduct the reimbursements as a business expense. (Ask your tax advisor for help setting up an accountable plan.)
3. Classify employees properly
Arguably, the biggest payroll management risk at the moment has nothing to do with individuals already on your company’s payroll. Rather, it has to do with those the IRS believes should be on your payroll. Specifically, the agency is concerned many employers are misclassifying employees as independent contractors to sidestep payroll taxes and benefits obligations. (And the IRS isn’t alone in its concern; see “DOL Misclassification Initiative”)
Under the simplest definition, if you have the right to direct and control a worker regarding the when, where and how of his or her work, this person is an employee — not an independent contractor. In such cases, you must issue the worker a Form W-2 and withhold and pay the appropriate payroll taxes. This pertains to both full- and part-time employees as well as seasonal workers.
If the IRS reclassifies an independent contractor as an employee, your business may face back taxes, interest, and even penalties. So carefully track the engagement, progress and project completion of each independent contractor. It’s risky having one of these individuals performing services for you indefinitely.
Moreover, double-check that no managers or employees are not issuing orders to a contract-based worker. Independent contractors should, among other factors, largely to completely control what they do and how they do it. They also need to pay self-employment taxes and incur a financial risk by working for your company. You should retain Form W-9 on file for these independent contractors and issue Form 1099 at year-end for payments made to them.
4. Maintain sound records
As you’re no doubt aware, employers must retain thorough payroll records for a variety of reasons. Applicable documentation includes hiring records (such as Forms W-4 and I-9) and ongoing employment records (such as time sheets, expense reports, and Forms W-2). Although not directly related to payroll administration, documents related to each employee’s performance reviews, disciplinary actions and terminations should also be retained.
Once again, even if your business outsources its payroll functions, maintaining a high visibility level of your payroll records is critical. It’s a good idea to periodically perform an internal audit of these records to ensure they’re in optimal shape. The worst time to learn you’ve lost or mishandled payroll documentation is after a lawsuit has been filed or an IRS agent is at the door.
Respecting the complexity
There’s a saying that goes, “The best way to manage payroll taxes is to pay them.” But it’s hardly that simple in practice. The process, tax distinctions, employee classifications and recordkeeping are so complex that, indeed, an entire industry has sprung up to manage it. As your company grapples with the risk involved, respect the complexity of payroll management and never let your guard down.
If you have questions about payroll management or other Entrepreneurial Services, contact Nicole Eshnaur at 816-743-7700.