Payroll for startups: 7 common mistakes to avoid
Angelo Sorbello

Published on December 8, 2023


Even the most well-meaning startups make payroll mistakes that slow down business, and worse, affect morale.

While making payroll mistakes is not by itself a sign of trouble, it still indicates that something is wrong with the startup's internal processes and culture. Here are seven crucial mistakes to avoid (particularly for US businesses).

Thankfully, there are some simple solutions that any startup can implement to make sure they're taking care of their employees.

[This is a guest post from Angelo and the team at LessAccounting. The recommendations - while great - do not constitute financial advice from Spendesk.]

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1. Classifying employees incorrectly

Treating an individual as an independent contractor while they should be deemed an employee under the law is an expensive mistake for a startup. Usually, new startups do so to avoid paying taxes and health premiums and to comply with some labor laws (e.g., overtime pay).

In addition, private workers are usually not eligible for the same compensation, such as pensions, life insurance, and other related benefits, as employees. Misclassification is particularly popular in startups, where people are often victims of "try before buy" recruitment.

If the job duties of a contractor don’t alter materially when they convert to an official employee, the IRS can charge the startup for misclassifying them at the outset.

There are also state-level fines to consider. The punishment for intentional misclassification in California, for example, varies from $5,000 to $25,000 per violation.

2. Mixing personal and business expenses

When the business is just getting off the ground, you'll have to make some unusual or difficult financial choices to keep things going smoothly. However, mixing personal and company finances remains one of the most frequent payroll mistakes made by small business owners.

We understand that keeping a company bank account separated from your personal money in the early stages is not easy, but you have to do it.

New businesses usually don’t make much money, so the entrepreneur might think that it's pointless to claim that they're paying their workers with company funds rather than their own.

This is a case of short-term thinking that can have a long-term impact. The startup will eventually have to untangle all of its expenses and pay back taxes. Furthermore, if the startup is either sued or audited, the hazy line between personal and business spending may expose the founder's personal assets to a court order.

One solution is, of course, a smart spend management tool.

3. Keeping incomplete records

Employers are required by the Fair Labor Standards Act (FLSA) to maintain payroll records for three years. These reports must contain the number of hours worked, wage scales, payroll processing times, and other relevant details required by statute.

Ensure that your payroll record-keeping procedures are up to date to defend your business against future possible penalties and litigations.

Make sure to review the local payroll record-keeping laws of the area where your company is located. Records must be held for more than three years in certain states.

4. Poor payment scheduling

Let’s be clear: it isn’t easy to manage payroll. The complexities of handling payroll tax duties at the city, national, and federal levels will quickly become a full-time task, particularly for a small company with a few workers. That’s why the majority of companies have a payroll service.

Payroll systems, on the other hand, will only take you so far. Employment-related provisions, such as worker's compensation, health benefits, new employee filings, and Form I-9, must also be considered by startups.

This is why many startups hire a Skilled Employer Organization (PEO) to handle payroll and assist them in complying with labor laws.

Via a PEO's "co-employment" partnership, you may cost-effectively outsource accounting, human resources assistance, health insurance, and workers' compensation administration.

5. Calculating payroll incorrectly

Calculating payroll accurately is more complex than just combining the employee’s hourly wage by the number of hours worked. Calculating an employee's total salary becomes very difficult as overtime, commissions, deductions, and PTO are added to the mix.

Receiving an incorrect paycheck would cause your staff to lose faith in your business quicker than anything else. It would be best to work alongside whoever is in charge of payroll on the team to ensure that all payroll processes and data are up to date.

The IRS has already been cracking down on misclassification, slapping significant fines and sanctions on guilty companies. In certain situations, deliberate neglect to pay salaries will result in criminal liability, which is much more significant than a fine. This is because the status of an independent contractor is determined based on several considerations, not only personal choice.

In other words, if a person's job is critical to a company's operations and the work it’s not a one-time project, the person should be classified as an employee.

This is why we suggest outsourcing the payroll, which we'll explore later in this article. This will ensure precise calculations and fast deposits.

6. Excessive healthcare and benefits payments

These days, the startup market is fierce. If you want to attract top-tier talent, especially developers, you must have excellent incentives and benefits like health insurance.

Keep in mind that health insurance premiums are costly, particularly for small businesses that pay more for less coverage. There is a maxim of leverage at work: the bigger the company's employee base, the better the bargain. But what can a startup offer?

Again, a PEO may be beneficial in this situation. Employees who serve for a PEO are combined with most of PEO's co-workers to create one big community. This ensures that, while working with a much smaller company, the PEO provides workers with insurance benefits and prices comparable to those of a major firm.

7. Failure to pay the overtime

If the workers are paid a set wage, you can think there is no reason to monitor their hours or compensate them for overtime. However, no matter how high your pay is, it would not exclude you from paying overtime.

Exemptions from overtime are rare, although they are based in part on the essence of the employee's work and responsibilities. If all of the company's workers are excluded from overtime, this could be seen as a red flag.

You could be facing a lawsuit for unpaid overtime if one of the overworked workers consults a counsel. Derivative allegations, such as claims of maintaining incorrect time reports, can also be made against you. Not only will this be a huge financial drag, but the bad publicity won't help you create the type of business atmosphere you like.

Payroll errors like misclassification or unpaid compensation, for most startup owners, are just part of the process of getting a business off the ground, rather than a nefarious scheme to elude the IRS.

However, regardless of the motivation behind these payroll errors, it's clear that even minor errors can have significant consequences. Consequently, it's essential to stay one move ahead of the game when it comes to payroll.

How to avoid these common startup payroll mistakes

To avoid making the typical payroll mistakes we discussed in the previous segment, you should take the following steps:

  • Maintain a clear payroll procedure checklist: even though technology can simplify most of the payroll phase, you should also have a thorough checklist to ensure the payroll is handled correctly.

  • Run a few reports before you start processing payroll: running checks such as a deductions review, payroll ledger, and cash request is an excellent way to spot some existing mistakes before they contaminate the payroll period.

  • When it comes to payroll software, don't be afraid to invest: consult the HR department to see if your payroll processes and technologies are current or outdated. Choosing the best Human Resources Information System (HRIS) for your company will make the difference between an efficient and a failed payroll management operation.
    And if you don’t have the money right now, even adopting small things, like FormPros' pay stubs and templates, can make a world of difference when it comes to payroll compliance.

  • Payroll outsourcing: try outsourcing the payroll to a professional third-party contractor such as LessAccounting to prevent expensive payroll errors. Payroll outsourcing companies are pioneers in all matters of payroll.

Final thoughts on payroll for startups

If you don’t want to outsource your payroll, make sure you understand exactly what it takes: as a company owner, you should be well-versed in the payroll phases from beginning to end.

If you can’t manage to go through the whole procedure in-depth, don't be shocked if you make a payroll mistake sooner or later.

As a business owner, you have to take care of many different aspects of your company: marketing, financing, accounting, expansion, investments, hiring, onboarding, acquisitions, mergers, and so on. Do you really want to add payroll, which is such a complicated and critical task, to the list?

Payroll outsourcing allows you to concentrate on what concerns you most: growing your company. Transfer the payroll to a specialist who has spent years avoiding and mitigating payroll risks, and you won't have to worry about a thing!

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