With the wide variety of record-keeping and reporting responsibilities deriving from legislation at state and federal levels, payroll software can help employers avoid penalties by automating much of the process. A 2011 Paychex report, Mastering Payroll Compliance, observes, “Businesses pay government agencies millions of dollars each year in labor and tax compliance penalties. And, in this economy agencies are more vigilant than ever about enforcing regulations.” Automated solutions can ease this reporting burden (and as such compliance questions should be asked prior to selecting a payroll software offering); however, in order to take full advantage of the software’s capabilities, an organization needs to understand the requirements. The following tips offer a starting point for federal compliance awareness.
Payroll Compliance Tip #1: Employer Identification Number
While it might seem simple enough (and not at all related to payroll compliance), the unique Employer Identification Number (EIN) identifies an organization for the purpose of taxes and other returns (and carries stiff penalties for willful negligence). Also known as a Federal Tax Identification Number, most businesses need an EIN (and probably an equivalent number for state taxes as well). According to the IRS, if an organization can answer ‘yes’ to any of the following questions then they must register for a number:
Do you have employees?
Do you operate your business as a corporation or a partnership?
Do you file any of these tax returns: Employment, Excise, or Alcohol, Tobacco and Firearms?
Do you withhold taxes on income, other than wages, paid to a non-resident alien?
Do you have a Keogh plan?
Are you involved with any of the following types of organizations?
Trusts, except certain grantor-owned revocable trusts, IRAs, Exempt Organization Business Income Tax Returns.
Real estate mortgage investment conduits
Payroll Compliance Tip #2: Correct Classification of Workers
From the point of view of an employer’s responsibilities, classifying a worker as an independent contractor can save expenses such as pension, group health, workers’ compensation insurance and social security and unemployment taxes. Reporting for contractors is similarly simplified with only the 1099 form to submit at the end of the year. However, the IRS are understandably focused on mis-classification as an issue; because (at the very least) classifying employees as contractors means lost federal revenue (and in some cases this wrongful classification is a deliberate tax avoidance strategy). The IRS website provides up to date definitions of the two terms.
Another classification issue lies within the Fair Labor Standards Act (FLSA) which includes employee protection on issues such as minimum wage and overtime. Those workers covered by the FLSA may be classified as ‘exempt’ or ‘non-exempt’. Exempt employees are not entitled to overtime pay. FLSA.com states, “Some jobs are classified as exempt by definition. For example, ‘outside sales’ employees are exempt (‘inside sales’ employees are non-exempt). For most employees, however, whether they are exempt or non-exempt depends on (a) how much they are paid, (b) how they are paid, and (c) what kind of work they do” and goes on to outline the details of how status is established on the grounds of salary level, salary basis and duties. Reclassification of workforce members following a federal wage and hours audit can result in fines, penalties and back-taxes, all of which the employer is usually liable for.
Payroll Compliance Tip #3: Social Security Contributions
The necessary social security contributions are divided between employer and employee (usually on a 50:50 basis) but the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 made some temporary adjustments that carry over into 2012. The IRS Employer’s Tax Guide for 2012 clarifies the current rates as follows: “The employee tax rate for social security is 4.2% on wages paid and tips received before March 1, 2012. The employee tax rate for social security increases to 6.2% on wages paid and tips received after February 29, 2012. The employer tax rate for social security remains unchanged at 6.2%. The social security wage base limit is $110,100.” Properly up-to-date software can keep track of rate changes for an employer and ensure that W-2 forms always contain the correct employee information (assuming correct data has been input to the system) and therefore reduce submission rejection rates.
Payroll Compliance Tip #4: Third Party Sick Pay
USLegal.com defines third party sick pay as, “a disability insurance benefit that provides employees with partial or full wage benefit payments while on long-term medical leave.” The payments are not made by the employer, but via the appropriate insurance company, union plan, or state disability plan. Many employers fail to realize that even though a third party is paying the employee’s salary, the employer is still liable for submitting W-2 returns—showing the amounts paid and withheld.
Payroll Compliance Tip #5: Garnishment of Wages
In the case of a court order demanding an employer make deductions from an employee’s earnings for the payment of a debt, the Consumer Credit Protection Act (CCPA) protects the ‘garnished’ employee from being let go simply because their earnings are subject to garnishment. Although garnishment carries an administrative burden, employers must be wary of seeking an ‘easy way out’ of the situation. Each garnishment order will have a case number and the inclusion of that identifying number on payments will reduce the likelihood of error or delay, and therefore penalty.
Payroll Compliance – The Bottom Line
The burden of payroll compliance can certainly be eased by software, but an organization cannot fully leverage the benefits without some core understanding and expertise regarding statutory requirements. As Paychex state in their white paper, “Employers owe it to themselves – to say nothing of their obligation to their employees – to be well-versed in tax, employment and benefits guidelines. At the same time, complying with state and federal statues is the first step in avoiding costly penalties”