Payroll Taxes: What Entrepreneurs Need to Know

4 min read · 8 years ago



  • 33% of small businesses get fined for doing payroll incorrectly, often because they’re trying to do it on their own and don’t know the nuances.
  • The biggest trigger of IRS audits is misclassifying employees as independent contractors.
  • Time is money: Entrepreneurs can spend the equivalent of three weeks each year dealing with payroll taxes, according to the NSBA. And it’s no wonder, considering….
  • … There are more than 15,000 tax codes in the United States and from 2001 to 2012, there was an average of one change a day to the tax code — staying compliant is important.

So, as an entrepreneur, what do you need to know to avoid payroll mistakes and save time in the proces?

In 1789 Benjamin Franklin wrote, “In this world nothing can be said to be certain, except death and taxes.” For many small business owners failure to comply with the thousands of employee tax regulations can actually lead to the death of their businesses.

That may sound like hyperbole, but it’s not. Last year, the IRS issued nearly 7 million penalties, totaling $4.5 billion, to U.S. businesses for making payroll errors.

That’s a lot of mistakes, many likely due to the fact that, according to Joshua Reeves, CEO of cloud-based payroll service ZenPayroll, “About 40 percent of all small businesses still do payroll manually, which leads to about 33 percent of small businesses getting fined for doing payroll incorrectly.”

Sometimes this is due to small business owners thinking they can “borrow” from payroll taxes, the part of federal, FICA, (Medicare and Social Security) and sometimes state taxes withheld on employees’ paychecks, to cover some of their operating costs. You can’t. The money belongs to the government, and borrowing it is illegal.

But more likely, a lot of these errors are honest mistakes, resulting from the sheer number of tax filings and forms small business owners are required to make. All employers are also required to pay FUTA (unemployment taxes). Adding to that, the various taxes have to be filed with different authorities, all with different filing deadlines. As Reeves explains, “In San Francisco alone there are nine different taxes employers have to file. And in the United States, there are over 15,000 tax codes.”

Given those odds, why do so many small businesses choose to do their payroll manually? Reeves says, “For so many companies that’s just how they’ve always done it, and they need something much better [to use] in order to change that behavior.”

You’d think the company’s accountant would head off a lot of these errors, but according to a survey from GoDaddy, 46 percent of small business owners don’t have an accountant.

Reeves thinks it’s unrealistic to expect entrepreneurs to get it right all the time. “Business owners shouldn’t have to be experts in what taxes they need to pay,” he says. “They should be spending their time doing marketing and selling.”

Don’t think your company is too small to worry about payroll taxes. As Reeves says, “Most of the pain comes when you add your first employee. There’s so much more complexity. It’s an immediate headache.”

The biggest trigger of IRS audits, says Steven Johnsen, Compliance Lead at ZenPayroll, is “misclassifying employees as independent contractors.” The IRS is on the lookout for these misclassifications since they can collect a lot of penalties and fines. (If you’re not sure what the criteria is, the IRS explains more on their website.)

Johnsen agrees being compliant with payroll taxes is difficult because “There are multiple agencies to pay with multiple deadlines. The more a business grows, the more and more labor intensive doing payroll becomes.” And the easier it is to make mistakes. For instance, payroll taxes need to be paid within a specific number of days after employees are paid. But there are eight different payrolls periods and two different deposit schedules you have to select from.

As Johnsen emphasizes, “Every time an employee is paid, a tax liability is due.” Things get even more complicated if you have employees (virtual or otherwise) in other states, since you have to comply with the rules of that state. State laws vary widely, Johnsen says, “The states have different filing frequencies, deadlines and rules. Some states won’t accept paper filings; they need to be electronic.” And, he adds, “Payroll is not even taxed the same. In some states it’s a flat percentage of wages, in others it’s a graduated rate.”

There are other payroll traps to avoid. Bonuses, for instance, are generally subject to a 25 percent withholding tax by the federal government, but the tax from the states varies from seven to 11 percent. And then there’s overtime. Overtime regulations, says Johnsen, also vary from state to state. Business owners need to know if the state defines overtime as working more than eight hours a day, or 40-plus hours a week. In California, for instance, an employee can work 9 hours one day and not work for the rest of the week, and the business needs to pay the employee overtime for that one hour.

Given all the complexities it’s easy to see why so many small businesses are paying the price. But there’s a solution: Outsource to a payroll company or hire an accountant. Working with a payroll partner enables you to focus on other parts of your business and also helps you stay compliant — without having to sacrifice any management decisions and responsibilities such as hiring, firing and compensation. ZenPayroll, for instance, works directly with small business owners, or with accountants who work with small businesses. As Reeves says, “You can’t automate the human touch.”

When looking for a payroll partner, Reeves says you should make sure the company not only takes care of actual payroll, but of filing all other necessary forms on your behalf. And, he adds, “look for an easy-to-use solution.” The products available today are incredibly intuitive and simple.

If you’re worried about the cost of working with a payroll partner, consider this: According to the 2014 Small Business Taxation Survey from The National Small Business Association (NSBA), some entrepreneurs spend the equivalent of three weeks a year dealing with payroll taxes. Eleven percent of those surveyed spend over 10 hours every month working on payroll taxes, while 43 percent spend between three and 10 hours a month. Why would any business owner want to do that?

As Benjamin Franklin (yes, him again) said, “Time is money.” Spending hours on tasks that don’t impact your bottom line, is a massive waste of time and money.

Rieva Lesonsky is a small business contributor for Fundera and CEO of GrowBiz Media, a media company. She has spent 30+ years covering, consulting and speaking to small businesses owners and entrepreneurs.