Even though payroll management is possibly one of the most vital jobs in any workplace, the complexity of the task makes it easy to get mismanaged. Payroll errors can impact employee morale and satisfaction levels, while increasing the likelihood of businesses facing the intimidating IRS audit, in the opinion of Charles Spinelli. Non-compliance with payroll tax laws or failure to keep records can lead to audits, fines, and damage to business reputation. Keep reading to explore the five most common payroll mismanagement mistakes that may cause an IRS audit.
1. Misclassifying Employees
One of the most common mistakes in payroll management is misclassifying workers. Many businesses label employees as independent contractors to avoid paying payroll taxes and benefits. However, the IRS has set stringent rules about how workers should be classified, and getting it wrong can lead to an audit.
If in an IRS audit, it is found that the business has deliberately misclassified workers, it can charge back taxes, interest, and penalties. It’s important to carefully review the working relationship and follow IRS guidelines to make sure workers are classified correctly.
2. Failing to Deposit Employment Taxes on Time
According to Charles Spinelli, employers are legally obligated to withhold and remit payroll taxes, including federal income tax, Social Security, and Medicare, within the specified timeline, and any delay in the process can immediately draw the attention of the IRS.
Equipped with highly sophisticated automated systems, the IRS team tracks deposit due dates and assesses penalties for missing even one deposit deadline. Charles Spinelli considers that employers should use an advanced and reliable payroll software alongside a knowledgeable payment administration team to remain compliant.
3. Erroneous or Incomplete Payroll Records
Keeping complete and accurate payroll records is not one of the best practices, but it is a legal mandate. The IRS expects employers to maintain documentation (W-4s, timecards, tax filings, proof of wages paid, etc.) for a number of years. If employers do not maintain this documentation, and they are audited, they can have a difficult time if any inconsistencies are noticed about the reported amount of income or with-holdings.
Employers should set up a secure and systematized record-keeping system to confirm that all payroll data is available and up to date.
4. Mistakes in Tax Form Filing
Filing inaccurate or incomplete tax returns, like W-2s, 1099s, or quarterly IRS Form 941, can raise eyebrows, triggering high-level scrutiny. Even minor errors, such as reversed numbers or wrong EINs (Employer Identification Numbers), can invite the IRS to investigate further.
To prevent these problems, employers should verify every form for accuracy before they are submitted and adopt payroll software that automates filing tax forms from payroll information.
5. Disregarding State and Local Tax Obligations
In addition to staying compliant with federal payroll taxes, businesses are obligated to the state and local tax rules and must comply with them with utmost seriousness. Failing to accurately report these taxes not only leads to an IRS inspection but also triggers an audit from state tax agencies.
Payroll tax rules vary among states, and employers who have offices with employees in more than one state must comply with each state’s rules. It is the best practice to outsource a tax professional knowledgeable about the tax rules of respective states to conform across jurisdictions.
To remain compliant and mitigate the risk of IRS scrutiny, companies should adopt thorough payroll practices with an expert in-house team or professional services alongside advanced payroll management software.
