6 Common Payroll Errors and How To Fix Them

Running payroll is a complex process. You have to calculate wages, taxes, and benefits for every employee in your business, and comply with labor laws that vary by location and change over time.

Naturally, errors are going to crop up here and there. But, if you leave them unchecked, you could be looking at IRS fines, back wages, and even employee morale problems, leading to high turnover and hiring troubles.

The good news is that most payroll errors are easy to fix, assuming you can spot them in time and you’re using the right payroll software.

In this article, we share the six most common payroll errors and their fixes.

Table of Contents Table of Contents

1. 1. Incorrect Worker Classification
2. 2. Failure To Adhere To State and Local Wage Laws
3. 3. Errors in Pay Rate
4. 4. Inaccurate Timekeeping
5. 5. Errors in Leave and Benefits
6. 6. Failure To Maintain Current Employee Information
7. Conclusion
8. References

Show Full Guide

Table of Contents

1. 1. Incorrect Worker Classification
2. 2. Failure To Adhere To State and Local Wage Laws
3. 3. Errors in Pay Rate
Show Full Guide
4. 4. Inaccurate Timekeeping
5. 5. Errors in Leave and Benefits
6. 6. Failure To Maintain Current Employee Information
7. Conclusion
8. References

1. Incorrect Worker Classification

What It Is

There are two types of workers: employees and independent contractors. Incorrect worker classification is when these two get mixed up—for instance, employees are paid as though they were independent contractors, or vice versa.

By law, employees and independent contractors need to be treated differently. Employees are covered under the Fair Labor Standards Act (FLSA), entitling them to a minimum wage, overtime pay, and sometimes insurance benefits.

Employees have their taxes withheld by their employers, and in the case of Social Security and Medicare taxes, employers pay half of employees’ taxes for them. This all results in easier tax preparation and reduced payments for the employee.

Contractors don’t have FLSA protections or employer tax withholdings.

Consequences

The biggest problems occur when employees are classified as independent contractors. If not corrected, misclassification can lead to severe penalties, including back taxes, fines, and interest from federal and state governments. It can also result in lawsuits for unpaid wages, neglected overtime, and unpaid benefits.

This error needs to be corrected as soon as possible since the longer you wait, the worse your fines will be and the higher the back pay.

How To Spot It

Stay on top of any changes to the labor laws, including the Department of Labor’s new “final rule” for how to determine independent contractors vs employees. In particular, look at the degree of control over the work performed and the level of independence in your workers’ roles. Regular audits and worker contract reviews can also help identify misclassifications.

How To Correct It

Once you spot this error, reclassify your workers immediately.

To reclassify independent contractors as employees, ensure they fill out a W-4 tax form, and begin withholding their taxes and providing benefits. To reclassify employees as independent contractors, stop withholding taxes and only provide benefits if you believe it will enhance the working relationship.

It’s important to note that good payroll software will automatically update to include changes in the tax code.

2. Failure To Adhere To State and Local Wage Laws

What It Is

Even if your employees are correctly classified, minimum wage, overtime pay, and sick leave all vary depending on the municipality and state where your business is based. And because these laws also change with time as new rulings are passed, it’s all too easy to be non-compliant and unaware of it.

Consequences

Failure to adhere to state and local wage laws results in many of the same consequences as worker misclassification.

Short-term consequences include government penalties and back wages. Long-term consequences include damaged company reputation and costly legal action against disgruntled workers.

How To Spot It

To reduce the probability of errors in the first place, stay up to date on official labor laws for your employees’ municipalities and states.

Large-scale payroll software solutions like Deel feature automatic tax code compliance based on your employees’ locations. To catch existing errors, make a regular habit of comparing your workers’ payroll with the official local and state guidelines.

How To Correct It

Time is of the essence when it comes to compliance with the authorities. When you spot an error, definitely don’t ignore it in the hope no one will notice.

For example, if you’re paying below your state’s minimum wage, immediately update this in your records, and calculate and pay any back wages owed. If you’re using payroll software, you can simply adjust the hourly rate, and the software will automatically calculate and pay the back wages for you.

3. Errors in Pay Rate

What It Is

This is when an employee’s hourly wage or yearly salary has been inputted incorrectly into your payroll software or spreadsheet, and the resulting paychecks are too low or too high. This often happens after an employee receives a pay rise, and the bookkeeper forgets to update the payroll with the new amount.

Consequences

Pay rate errors lead to overpayment or underpayment, which affects employee satisfaction as well as your business’ financial planning.

Overpayments can be particularly problematic since they create unnecessary (and unexpected) financial strain on your business, as well as complications in recovering the funds. After all, how many employees will be thrilled to cut a check back to the company they work for?

How To Spot It

The best way to spot pay rate errors is to keep multiple sets of documentation of your employees’ wages and compare them periodically.

Your payroll software counts as one set, but you should also have a separate spreadsheet with a timeline covering the whole year. Give each employee their own row, and calculate what their pay should be each time you run payroll. Make sure one of your accountants is responsible for updating this spreadsheet every time an employee gets a raise.

How To Correct It

If you discover an underpayment, correct the pay rate as soon as possible and issue back pay for the difference owed. For overpayments, communicate transparently with the employee to arrange for repayment.

If you can correct pay rate errors within a few months of occurrence, corrections are usually much simpler, since you’re dealing with less money. Errors discovered after a long time usually require a more sensitive approach and even legal consultation, especially for any serious overpayments.

4. Inaccurate Timekeeping

What It Is

Inaccurate timekeeping is when hourly employees are paid for the incorrect amount of hours worked.

Employees are usually responsible for tracking their own hours, whether it’s with punch cards, time clocks, or digital timesheets as part of their company’s payroll software. As a result, this is one of the only payroll errors that’s usually the employee’s fault—whether intentionally or unintentionally.

Consequences

Regardless, it’s still your responsibility as the employer to identify timekeeping errors and correct them. If you don’t, and your employees are consistently underpaid, you may be looking at costly lawsuits. However, if your employees are intentionally over-recording their hours worked, this is considered time theft, and it gives you the precedent to take legal action against them.

In either case, you’d be spending valuable company time fixing unnecessary problems. It’s much better to avoid these errors in the first place.

How To Spot It

It’s very difficult to spot this error by simply examining your payroll amounts since you also need to know how many hours your employees actually worked.

Cutting-edge businesses use devices like fingerprint and face scanners to ensure employees are physically on site when they say they are. Some newer payroll solutions also include automatic time-tracking features that record hours worked only when employees are detected as being active on their computers.

How To Correct It

Correcting inaccurate timekeeping depends on what’s causing it in the first place. If your employees are unintentionally making timekeeping errors, it’s still your responsibility as the employer to correct the errors and issue back pay. If they’re intentionally engaging in time theft, it’s up to you to proceed with legal action.

Whether accidental errors or time theft, consistent timekeeping problems warrant new accountability measures like biometric scanners or payroll products with automatic time tracking.

5. Errors in Leave and Benefits

What It Is

Leave and benefits include paid time off, sick leave, health insurance, and retirement plans. Common payroll errors involve deducting too much or too little from an employee’s paycheck for benefits or failing to provide enough paid leave for vacationing employees.

Consequences

Payroll errors with leave and benefits have both legal and internal consequences. Legally, improper health insurance and retirement contribution amounts can violate the Affordable Care Act (ACA) or the Employee Retirement Income Security Act (ERISA), resulting in hefty penalties.

Internally, these errors can cause employee frustration and turnover, as well as lost time and resources. Your HR department will need to identify the errors, calculate the correct balances, and communicate the changes to affected employees.

How To Spot It

The best way to spot these errors (and prevent them in the first place) is to use payroll software that automatically calculates and distributes benefits. However, human accountants are responsible for updating the software with any changes—so errors can still happen.

Just like with pay rate errors, you should keep a separate spreadsheet detailing the benefits each employee is owed, and periodically compare this with the amounts in your payroll software.

How To Correct It

To avoid legal action, you should reimburse employees for any missed compensation, and of course, make the correcting adjustments in your payroll software.

6. Failure To Maintain Current Employee Information

What It Is

This is when employee information (such as address, marital status, or number of dependents) is not updated properly in the payroll system. Though these details aren’t intrinsically important on their own, the wrong information can cause a domino effect, including incorrect tax withholdings, incorrect emergency contact information, and reduced eligibility for benefits.

Consequences

The biggest consequence of incorrect employee information is tax penalties. For example, an incorrect Social Security Number could lead to rejected tax documents. Failure to account for a remote employee’s new place of residence could result in incorrect state tax withholdings, and late updates of an employee’s newly married status could cause you to miss certain tax deductions.

At the least, all of these entitle your employees to back pay. At the most, they give your employees the right to pursue legal action against you for non-compliance.

How To Spot It

Just like with leave and benefits errors, automation is the best way to spot and prevent employee information errors. In 2024, most payroll solutions have automatic tax code updates for employee information changes, such as location or marital status.

Provide your employees a clear, easy path for updating their personal information themselves, as well as incentives to do so in the first place.

How To Correct It

Outdated employee information is undoubtedly an HR problem. So, upon discovering any inaccuracies, update the employee’s information in the HR system immediately.

If you’ve already run payroll using the incorrect information, adjust it in the next payroll cycle. For example, if you’ve withheld too much money for taxes, calculate the amount of the error and increase the employee’s next paycheck by that amount.

Conclusion

Since running payroll is such a complex process, errors are unfortunately common. However, leaving payroll errors unresolved can cause penalties and fines, late payments to employees, and even serious reputation problems.

Understanding the most common problems and their consequences, knowing how to spot them in time, and correcting them immediately can save you and your business from unnecessary revenue loss or legal complications.

Minimizing payroll mistakes always starts with using the best payroll software. Features like automatic tax updates and real-time error checking are essential for making timely corrections, as well as preventing errors in the first place.

Robbie Mizzone

Editor

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Robbie Mizzone

Editor

Robbie holds a BSc in Accounting and Finance from Centenary University, New Jersey. He's worked for banks and private companies alike, including Kering (Gucci, Balenciaga), focusing on financial reporting, account reconciliation, and complex accrual analysis. An avid explorer and jack of all trades, Robbie's garnered experience in luxury hospitality, carpentry and construction, and is now backpacking solo around the world.

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