6 Things You Didn't Realize About Payroll

Many business owners view payroll as a simple matter of processing paychecks and maintaining basic records. However, Christina shows us that there's a complex web of regulations, requirements, and potential pitfalls that can significantly impact your business's bottom line and legal compliance. From employee classification to multi-state hiring challenges, here are six important aspects of payroll that might surprise you.

1. Employee vs. Contractor

The most common mistake Christina has seen among small business owners is misclassifying workers. Many businesses believe they can designate someone as a contractor simply because they work remotely or bring their own equipment. However, it's a little more complex than that. The determining factor is whether the person is performing an integral part of your business services.

One of the clearest indicators of contractor status is the ability to set their own rates and terms. Real independent contractors, like Christina's own payroll company, determine their pricing, billing structure, and service terms. If you're setting an hourly rate and payment schedule, you're likely dealing with an employee relationship, not a contractor.

The consequences of misclassification can be severe. When businesses incorrectly classify employees as contractors, they avoid paying unemployment tax, workers' compensation, overtime, and various state-mandated benefits. If caught, businesses must retroactively pay these taxes and benefits, plus penalties and interest. While audit risk might seem low, it only takes one disgruntled worker filing an unemployment claim to trigger an investigation.

2. Payroll Software Is a Tool, Not a Solution

Many business owners believe that purchasing payroll software will automatically ensure compliance and correct processing. However, that software is merely a tool – it's only as good as the information you put into it. Without proper knowledge of payroll regulations and requirements, users can make serious mistakes even with the most sophisticated software.

Common software-related issues arise when businesses handle multi-state employees. For example, if a Texas-based company hires a Washington state employee but enters their work location as Texas, the software won't apply Washington's specific requirements for paid family medical leave and other state-mandated benefits. The software can't identify these errors because it's working with incorrect input data.

Christina shared that it's like building a house. Having all the right tools doesn't mean you know how to build one. Similarly, having payroll software doesn't ensure you're processing payroll correctly. The human element – understanding regulations, identifying potential issues, and knowing when something doesn't look right – is necessary for accurate payroll processing.

3. Remote Work Has Changed Everything

The COVID-19 pandemic fundamentally transformed how businesses handle payroll, particularly with remote work. While many larger corporations are now requiring office returns, small businesses, especially those started post-COVID, often embrace remote work as their standard model. Unfortunately, this creates new payroll complexities that many business owners don't anticipate.

Remote work across state lines introduces numerous compliance requirements. Each state has its own regulations regarding paid family leave, sick leave mandates, retirement mandates, and pay frequency requirements. The shift to remote work has also led to changes in document verification processes, with new requirements for electronic I-9 verification and e-verify compliance.

Technology has become increasingly crucial for even the smallest companies, with many now utilizing electronic timekeeping, automated onboarding, and integrated benefit enrollment systems. While these tools can streamline processes, they also add complexity to payroll management and require careful attention to ensure proper setup and use.

4. State-by-State Compliance Is More Complex Than You Think

When hiring across state lines, businesses face varying levels of complexity depending on the states involved. Some states, particularly California, Washington, and New York, have extensive requirements that can significantly impact your bottom line. 

Here's a list of considerations when hiring in different states:

1. Registration requirements in each state

2. State-specific unemployment insurance rates

3. Workers' compensation requirements

4. Paid leave mandates

5. Retirement plan requirements

6. State-specific new hire documentation

7. Training requirements (like California's mandatory harassment prevention training)

8. Tax implications and nexus considerations

Proper planning and understanding of these requirements are crucial before hiring in a new state. Christina recommends conducting a cost-benefit analysis using tools like an employer cost calculator to make informed decisions about interstate hiring.

5. S-Corporation Requirements Are Often Misunderstood

Many business owners convert to S-corporations for tax benefits without fully understanding the payroll implications. Often, CPAs recommend the switch but don't fully explain the ongoing requirements, leaving business owners confused about proper payroll practices.

S-corporation owners must pay themselves a reasonable salary through payroll, separate from distributions. This requirement often catches owners off guard, especially when they've already been paying themselves through distributions. The key is understanding that while S-corporation status can save on self-employment taxes, it comes with specific payroll requirements that must be properly managed.

This becomes further complicated when considering what constitutes "reasonable compensation" and how to handle various types of deductions. Many S-corporation owners are surprised to learn they can't take certain pre-tax deductions available to regular employees, highlighting the importance of working with knowledgeable payroll professionals.

6. The Rules of Overtime

Overtime calculations extend beyond simply multiplying hours over 40 by 1.5 times the regular rate. Many businesses don't realize that non-discretionary bonuses must be factored into overtime calculations, a requirement that many payroll software systems don't handle automatically.

The proper classification of exempt versus non-exempt employees is another critical area where businesses often make mistakes. Many employers incorrectly assume that paying someone a salary automatically makes them exempt from overtime. Salary is just one component of the exemption test, and misclassification can lead to significant liability for unpaid overtime.

The risk of overtime mistakes is particularly high because there's no statute of limitations on wage claims in many jurisdictions. If an employee files a complaint, businesses might have to reconstruct time records and pay back wages, often with penalties and interest.

Protecting Your Business

As businesses grow and evolve, especially in our increasingly remote work environment, proper payroll management becomes more critical than ever. While it's possible to handle payroll internally, the complexity of regulations and the potential consequences of mistakes make professional assistance valuable for most businesses.

Consider evaluating your current payroll practices keeping in mind the issues discussed above. Are you confident in your worker classifications? Do you understand the implications of hiring in different states? Are you meeting all the requirements for your business structure? If you're unsure about any aspects of your payroll management, consider consulting with a payroll professional who can provide guidance specific to your situation.

Investing in proper payroll management isn't just about compliance – it's about protecting your business and ensuring your employees are properly compensated. Whether you choose to handle payroll internally or work with a service provider, understanding these complexities is crucial for making informed decisions about your business's future.