1. MISCLASSIFYING EMPLOYEES AS INDEPENDENT CONTRACTORS
It is critical that business owners properly determine whether individuals providing services to the business are employees or independent contractors. When you hire employees, you must withhold proper taxes and pay the company’s portion of Social Security and Medicare tax, plus federal and state unemployment taxes. This can be costly, so many business owners choose to work with independent contractors. Follow the IRS guidelines to properly determine the relationship with the individuals who provide services to your business in order to avoid penalties and back taxes.
2. FAILING TO TIMELY DEPOSIT WITHHELD TAXES
When you are late on your deposits to the IRS or the state, you are not only liable for being late on paying the company’s portion of payroll taxes, you are also liable for remitting the employees’ withholding late. When paying your staff, the difference between gross and net pay is the employees’ portion of taxes which you are holding in escrow and are supposed to remit to the government according to the schedule assigned to you. Failure to do so will definitely cost you, and it happens more often than one would think.
3. FAILING TO FILE TIMELY PAYROLL REPORTS
When you first hire employees, the state requires that you file a new hire report on every new or rehired employee. These reports often get overlooked. On a quarterly basis, the IRS and the state require that you file payroll forms to report wages paid, income taxes withheld, and Social Security and Medicare taxes for both the employer and employees. After the year-end, there are additional forms to be filed, such as the federal unemployment report, W-2s and 1099s. Keeping track of all these reports gets confusing, yet making a mistake may turn out very expensive. It is recommended to get an accounting professional to help you navigate through the reporting requirements.
4. NOT PAYING YOURSELF REASONABLE COMPENSATION
If you are self-employed (sole proprietor), it is very straight forward as to what your compensation is. You pay income taxes, as well as self-employment tax on your net income. However, if your business entity is a corporation or an S-corporation, generally you must receive reasonable compensation in the form of wages or salary and pay both income and payroll taxes, just like other employees. The general guideline to determine your reasonable compensation is what you would be paid for the same type of services if you were to work for another similar business. S-corporation owners have been under the increased scrutiny by the IRS in the recent years because they generally prefer to take distributions and thus avoid payroll taxes. Such mistakes can cost your business a lot of money in penalties, back taxes, and interest.
5. NOT KEEPING PROPER RECORDS
You are required to keep all records of employment taxes for at least four years. Such records include, but are not limited to amounts and dates of all wages, tips, and bonuses paid, employee and independent contractor information, such as names, addresses, and SSNs, dates of employment, copies of payroll reports filed, and dates and amounts of tax deposits you made. If you are paying yourself as an officer of a corporation or an S-corporation, keep the records of how you came up with the amount of your salary and why you consider it reasonable. Failure to keep proper records becomes a nightmare during an audit and can cost you a lot in your time and possible tax consequences.
To avoid making any of these mistakes, consult with an accounting professional when first setting up payroll for your company. The accounting technology today allows us to provide payroll services at more affordable rates, and many business owners prefer that we take this off their hands. If you have payroll questions, do not hesitate to schedule a free consultation and have your questions answered.