Common Payroll Mistakes Companies Make
Luke Luckett, CPA, Tax Associate
As part of the Employment Tax Research Project launched in 2010, the IRS is reviewing the payroll practices of employers in four main areas: Worker misclassification, fringe benefits, executive compensation and payroll taxes. The IRS is focusing on employment tax issues and pursuing penalties to help close the tax gap. Here is a list of common payroll mistakes companies make:
- Worker Misclassification – Workers are commonly classified as either independent contractors or employees. Some key factors to determine whether the worker’s status should be considered as an employee are whether the worker is in control of how to do their own job, who provides the tools and if there are written contracts regarding benefits. This will determine how compensation gets reported to the IRS; either Form W-2 or Form 1099.
- Fringe Benefits – Most prizes and awards are considered taxable fringe benefits and are subject to federal income tax and employment tax withholding. Items that are de minimis in nature are excluded, but cash equivalents are never de minimis. One common cash equivalents are gift cards and should always be included in taxable wages regardless of the amount. Correctly valuing fringe benefits for purposes of income and employment tax reporting and withholding can be a complicated issue.
- Executive Compensation – When employees exercise stock options, employment taxes should be deposited within one day of the settlement date. When employees receive restricted stock, they generally recognize income upon vesting. Employment taxes must be deposited the next business day. Failure to meet these deposits will result in penalties.
- Payroll Taxes – Depending on the amount of taxes withheld, a company is required to deposit taxes on a monthly or semi-weekly basis. If a company doesn’t timely deposit these taxes, the company may be subject to late deposit penalties and interest. Penalties can range from 2 to 15 percent.
With the IRS expanding their audit scope and depth of diligence, companies should look at their payroll practices and make any necessary corrections before the IRS comes knocking on their door. You can contact your Anders advisor with further questions and details.