Tag: How-to

Conducting a payroll audit can help your small business reduce employment costs and ensure compliance with federal, state, and local labor laws. Start the process of analyzing your company’s payroll to reveal errors and inefficiencies that reduce your bottom line.

How To Conduct a Payroll Audit in 8 Steps

Your small business payroll audit should have two main goals. First, you want to make sure that you have comprehensive payroll documentation for all your employees, and verify the accuracy of these records. After you fix any errors you uncover, the second step involves finding the issues in your internal processes that led to discrepancies and updating protocols to improve the accuracy of your company’s payroll records.

If you aren’t convinced of the importance of running regular payroll audits, consider these statistics:

• Employers paid about $6 billion to the IRS in payroll-related penalties in 2020 alone
• A survey from Intuit revealed that 25% of employees have received paychecks that contain errors
• 18% of employees surveyed by Intuit said they have received a late paycheck, which increases to 32% among those who work for a company with 20 or fewer employees
• Kronos reports that nearly half of employees will look for a new job after more than one paycheck error
• Up to 30% of U.S. employees are classified incorrectly, according to the National Employment Law Project
• 45% of small businesses have no accountant or bookkeeper on staff and 25% still have a paper payroll process, as revealed in data collected by Clutch.co

Small businesses are also more likely than larger businesses to experience payroll volatility. This phenomenon is characterized by high levels of turnover and other changes that increase the chances of errors and other issues.

Before You Begin

While the word audit conjures images of endless stacks of paperwork, you can streamline the process with these eight easy steps. Before you get started, you’ll need to gather the necessary reports from your paper accounting records or payroll software system.

Type of Payroll Report

Purpose

Company-wide payroll reports

Also called a payroll register or payroll journal, a comprehensive document that includes all the details of employee compensation, tax withholdings, and deductions

Employee time reports

Details about the number of hours worked per employee per pay period (weekly, bimonthly, monthly)

Individual employee reports

Detailed compensation, withholding information, and deductions for a single employee

Payroll tax reports

Quarterly and annual reports that detail taxable employee compensation and corresponding withholdings and tax liabilities

Cash requirements reports

Information about the amount of money your business needs to process payroll and the allocation of these funds

1. Analyze Your Payroll Roster

Download your payroll roster from your company’s accounting software. Once you have this document in front of you, review your entire payroll to confirm that it doesn’t include “ghost” employees who don’t actually exist, a sure sign of internal fraud. Verify each person’s full legal name, Social Security number, current address, and position at the business.

Take this time to remove anyone who no longer works for the business. This includes workers who are currently out on disability or family and medical leave. If you employ external vendors or contractors, the payroll audit offers an opportunity to check their contracts. Make sure they have been paid only the amount owed under the designated contract period.

2. Check Pay Rates and Hours Worked

Once you verify that your payroll only includes humans who actually work for your company, make sure that they are getting paid the correct amount for the correct number of hours. Unscrupulous employees who have access to the payroll system sometimes increase compensation rates or boost the number of hours someone works so they can embezzle money. The audit should look at every timesheet and paystub for every work for the entire period since you last conducted a payroll audit.

In addition to verifying hours worked and pay rates, make sure that you have accurately distinguished between hourly and salaried employees. You must also ensure the correct classification of exempt and nonexempt employees under the provisions of the Fair Labor Standards Act. Employees who are nonexempt must receive overtime pay for every hour they work over 40 hours a week. If these workers have not been compensated correctly, adjusting this issue and providing back pay accordingly can prevent state or federal sanctions.

3. Look Closely at Variable Payments

Make sure that any employee payments that diverge from the typical amount are supported by proof of authorization. The journal of your payroll system should have a separate section for variable pay apart from standard salaries and wages. Some of the most common types of variable payments include shift differentials, profit-sharing payments, commissions, and bonuses.

4. Review Off-Cycle Payments

You also want to pay special attention to payroll cycles that occur outside the typical amount. For example, if your company should have had 24 semi-monthly payroll cycles in the year since you last conducted an audit, you need to investigate unexplained extra cycles. While some such variances could be an error or occur when the company issues a bonus or other special incentive, they could also be a red flag for fraud.

5. Perform Payroll Reconciliation

In this step, check each payroll record against the company’s general ledger. This reconciliation represents the most important part of the payroll audit, and it typically takes more time than any other step. Double-checking the journal entries in your business accounting software that correspond to your payroll records ensures that the system transmitted this data correctly. It also confirms the correct calculation of taxable wages and payroll deductions.

6. Check Payroll Records Against Tax Forms

Next, you need to make sure that your payroll records match up with the amounts you reported on IRS Forms 940 and 941. Form 940, filed annually, reports tax your company withheld under the Federal Unemployment Tax Act. On your quarterly Form 941, you report withholding of federal income tax and Federal Insurance Contribution Act taxes. In addition to reconciling your payroll records against your federal tax forms, you also need to check against the corresponding state forms.

7. Locate and Pay Outstanding Tax Bills

Your payroll system likely creates automatic tax liability reports when you owe outstanding tax payments. This may occur if the system fails to make these payments when you hire someone living in a different state and do not enter a specific tax ID number for that state. In this situation, the payroll audit ensures that you can pay the outstanding amount and avoid costly IRS sanctions.

8. Establish or Improve Payroll Protocols

When done correctly, payroll audits should enhance your company’s processes to reduce the potential for errors and fraudulent activity. End each payroll audit with a wrap-up session where you discuss findings and determine how your business can avoid these issues in the future. If you don’t have a solid payroll protocol in place, consider these best practices:

• Direct supervisor approval of each payroll run
• A weekly deadline for timesheet submission
• Documentation in writing for variable payments such as bonuses
• Restricted access to payroll on an as-needed basis
• A single pay cycle for all employees
• Modern payroll software if you don’t already have this technology in place
• A paperless reporting process to automate the audit
• A regular review of state and federal labor laws to ensure ongoing compliance
• A system of checks and balances that divides payroll responsibilities among team members

In addition, if you don’t already have a pay policy in place, establishing this type of document can prevent issues such as employee misclassification, tax underpayment, and accidental and intentional time theft. Your company’s pay policy should include transparent details about employee classifications and determination of salaries, wages, raises, and promotions. This document also details the protocol for processing payroll, making changes to this process, and addressing errors that arise. This level of transparency not only reduces the likelihood of errors but fosters a trusting relationship with your workers.

Benefits of Conducting a Payroll Audit

While you may be reluctant to dedicate valuable internal resources to an annual audit, most small businesses realize a substantial return on this investment. Some of the advantages of conducting regular payroll audits include:

• Finding and correcting data entry and calculation errors
• Detecting and discouraging payroll fraud
• Identifying changes that need to be made, such as removing a terminated employee or adding a raise for a promoted worker
• Confirming accurate tax withholdings and payments
• Correcting the accounting for sick, personal, vacation and holiday time
• Verifying you are paying workers for the correct number of hours
• Remaining compliant with state and federal employment regulations
• Reducing your risk of an external audit by correcting problems before they are flagged by the IRS
• Evaluating the cost of your payroll software and user licenses relative to features and value

Issues in any of these areas could be costly for your business, and without regular audits, multiple problems with payroll can arise and go on for some time without notice.

As your business grows, a payroll audit could reveal the need for an employee audit. With this process, you review the company’s org chart and hiring plan to determine whether it aligns with your organizational goals.

Best Practices for Easy Payroll Audits

If you keep putting off the payroll audit process because you don’t have the time, money, knowledge, or staff, you’re not alone. Fortunately, you can take measures to make the audit easier and detect underlying issues that can cost even more to correct as they persist over time.

Especially if you do not have education in accounting, consider hiring an accountant or bookkeeper to conduct an internal audit on behalf of your business. Engaging professional services can reduce the risk of expensive payroll mistakes as well as save your time for your core business operations. You don’t necessarily have to bring on a full-time staff member; instead, hire a CPA at an hourly rate to help out when needed or outsource this job to a third-party firm.

If you prefer to keep the audit internal, it doesn’t have to take over your life at work. Instead, consider spreading the items on your audit checklist over the entire year and take on just a few tasks each month. You can also delegate the tasks among team members to reduce the workload associated with the audit.

Remember that putting off a payroll audit just means pushing the work down the road. Eventually, you may have no choice but to audit your payroll records when faced with an IRS audit or a U.S. or state Labor Department claim.

Using Accounting Software for Your Payroll Audit

While manually entering payroll may work fine when you have just one or two workers, it dramatically increases your risk for errors in the process of paying your employees. You can also run into issues if you rely on old, outdated software to run payroll. Fortunately, small businesses can choose from several free payroll software options.

When selecting the right accounting software for your payroll audit, consider these factors:

• Whether the system can integrate with your company’s existing hardware and software
• The software’s ability to issue direct deposits, paper checks, or both
• The learning curve associated with using and mastering the system, including available training resources
• Whether it offers a self-service portal where employees can enter and verify their own information as needed
• The number of employees you have, since some systems limit the number of payroll records you can create

If free software options for payroll don’t quite meet the needs of your business, expect to pay about $30 per month for a flat-fee service or $4 to $12 per month per individual employee access license.

Bottom Line on Payroll Audit

Auditing payroll records for your small business can seem like an arduous, expensive process. Fortunately, each time you successfully conduct an audit that results in improvements to your payroll system, you reduce the likelihood of errors. This in turn will streamline and shorten the next planned payroll audit.

Following these simple steps can take the stress out of analyzing your company’s payroll records. If you don’t already have an organized system in place, regular audits can significantly reduce the chance of problems with your company’s payroll.

Your business has reached a point where you can’t handle everything on your own. Hiring employees seems like the obvious next step. However, doing so adds a layer of complexity to running a business that will forever change how you spend your time. One of your biggest new responsibilities and time sinks will be payroll.

What is payroll? Not all new business owners are familiar with this concept and it’s a good idea to start off with a brief explanation. Payroll is the organized process of calculating wages owed to employees, calculating and paying payroll taxes, distributing employee wages, and documenting the whole process.

How to Do Payroll with Payroll Software In 11 Steps

Since payroll is a broad concept that covers everything from payroll laws and taxes to documentation, it can be a bit too much to wrap your head around. It’s easy to run into errors if you’re running payroll on your own for the first time. Remember that the penalties for an error in taxes or employee paychecks are no joke. 

Small business owners, even those with only one employee, should certainly invest in a consistent method for running payroll. Rather than doing payroll manually, we recommend you use payroll software. These payroll processing services will manage the entire process for you from paying your employees, calculating payroll taxes, paying and filing them, to managing employee benefits.

Although different payroll software may have slightly varying steps to run payroll, the overarching process is almost the same. So here’s your easy guide on how to do payroll for your small business with payroll software. We’ll be using screenshots from the Square Payroll setup process to help you along the way. 

Step 1: Choose a Payroll Software that Suits Your Needs

The first and most important task on your hands is to choose the right payroll software. You’ve got plenty of options to choose from, but if you’re new to payroll, you can’t immediately tell which software is right for you.

Plus, some not-so-good payroll service providers run relentless ad campaigns and you might end up subscribing to them if you’re not well-informed about which one suits you best. To ease things for you, we’ve researched the market and enlisted the best payroll software for different kinds of businesses. Here are our top three picks. 

Gusto

Built for small businesses, Gusto is a robust platform that unifies payroll, benefits administration, HR, and compliance functions into a single, easy-to-use package. It offers a range of payroll tools to simplify and automate the entire process of paying your employees. Plus, advanced plans have HR services to help you and your employees make the most of your time. Read our in-depth review on Gusto to find more about it. 

Square Payroll

Square Payroll is an easy-to-use payroll software with a simple design and all tools accessible from the homepage. It lets you manage employees’ paychecks with ease and offers seamless timecard imports, automated tax filings, and a range of other helpful features. Check out our Square Payroll review to see if it suits your needs. 

Rippling

Rippling is a high-end payroll service and is a great option for mid-sized businesses. It offers HR functionalities as well as powerful payroll tools which makes it great for personnel management. Rippling also offers loads of integrations with accounting, time tracking, attendance, and other tools. 

Step 2: Set Up Employer Account on Payroll Software

Enter your personal details and your business’s information to set up your account. You just need your business name, type, address, and contact information to complete this step. Once down, you can move on to adding your employees’ information. 

Step 3: Add Employees to the Payroll Software

Add your employees using basic information such as their full name, email address, and employment type. You don’t need to go into detail; all technical stuff is handled by the software on its own. Once you’ve added the employees’ basic information and email address, the software sends them an email invite so they can complete the rest of the process on their own.

This means according to their employment type, the payroll software requests them to fill in tax forms such as the W-4, I-9, or 1099s to process contractor payroll. If you’re not using payroll software, you need to gather this information and deal with all the paperwork on your own.

Using these employee-filled forms, the payroll software automatically sorts out exempt and non-exempt employees, information about taxes and employee benefits, and other important information to run payroll.  

Step 4: Enter Tax Information

This is where you enter your business’s tax information such as the EIN number and state tax IDs so the payroll software can use them to file payroll taxes on your behalf. Find your employer identification number (EIN), if you don’t already have it, you can apply for it free on the IRS website. 

Your EIN, also known as your business’s federal tax number, helps the IRS and the government identify your business. It’s just like your company’s social security number and is essential for you to file payroll taxes. 

Also, check if your state or local government requires a different identification number such as the state income tax number, or state unemployment ID. Most states just need the EIN, but it’s a good idea to check before you continue. Once you have all the information required to set up your employer profile on the payroll software, it’s time to create your account.

Step 5: Select a Payroll Schedule and Payment Method

Once you’ve set up your account on the payroll software, you need to decide on a payroll schedule and the payment methods you’re going to offer. There are four types of payroll schedules. This includes weekly, bi-weekly, semi-monthly, and monthly schedules. But remember each state has its own pay period requirements. 

For example, your state may require weekly or biweekly paydays, depending on the occupation. We recommend you check out your state payday requirements to ensure compliance. 

In some states, the law mandates that you offer multiple payment options for your employees. Paper checks are becoming rare options for employee paychecks, and are being replaced by methods more convenient for both employer and employee, like direct deposit. Another option is pre-loaded payroll cards, similar to prepaid credit cards. 

Step 6: Use a Time Tracking System

You must have an accurate time tracking system in place to track your employees’ worked hours. The FLSA makes it a must for employers to accurately track hours for their hourly employees. A simple solution is to use spreadsheets, but if you want a more advanced solution, use time tracking software. 

Employees can clock in and out their hours through the tracking system. By integrating the time tracking app with your payroll software, you can import the total hours worked instantly. Not just that, issues like determining overtime hours are also taken care of. 

Step 7: Run Payroll

Once everything is set up and you’re ready to pay your employees, your payroll software gives you an option to run payroll for a given pay period. After you verify information, you can simply press a button to pay workers.

Step 8: Input Employees’ Hours or Import Timecards

With payroll software, you can either input employees’ hours worked manually or import them through the time tracking system you use. Note that the latter is the faster and more efficient way to pay your employees accurately.

If you import timecards, the hours each employee has worked are automatically entered. If employees have worked overtime or double overtime, those hours are entered accurately too. Note that you can still edit these hours manually if needed. 

Next up, you can add any additional payments, paycheck tips, or take cash tips into account. The payroll software uses this information to accurately calculate the gross pay for each employee. 

Step 9: Deductions and Adjustments

The most complicated part of payroll processing may be calculating and paying payroll taxes. This complexity is due to several factors. As an employer, you must calculate both what you and your employees owe when determining your company’s total payroll tax liability. Employers should withhold income taxes and other payroll taxes from employees’ wages, to be paid on their behalf. 

Federal taxes include federal income tax, as well as the federal unemployment tax. Deductions governed by the Federal Insurance Contributions Act (FICA), including medicare tax and social security tax, also need to be tracked and paid. Taxes are also owed at the state level, including but not limited to state income tax and state unemployment tax. 

All of this is taken care of by the payroll software. It calculates all taxes accurately so you don’t have to worry about any of that. You just need to make sure if there are any extra adjustments you want to make in each employee’s paycheck. For example, if you’ve received a garnishment order or want to make a post-tax deduction, you can at this stage. 

Step 10: Review Payroll Run Summary and Pay Your Employees 

Finally, the payroll software takes you to a review page where you can see each employee’s net pay and all payroll taxes and other deductions in one place. Once you’ve reviewed it, you can finally pay your employees by confirming withdrawal. 

Note that if you opt for direct deposit, the payments can take two to four days to reach your worker’s bank accounts. Other payment methods can take varying time periods to reach employees. 

As a note, pay stubs from each pay period showing information like deductions are made available to employees. This can be an additional concern but is not a problem if you use payroll software.

Step 11: Keep Payroll Records

Paying employees generates a lot of paperwork, some of which needs to be saved. Not keeping this paperwork safe is one of the most common payroll mistakes new employers tend to make. Records of payroll tax forms and other information have to be saved for at least four years. 

These records include:

• Your employer identification number
• Amounts and dates of all payments to employees
• Tips reported
• The fair market value of in-kind payments, ie. trading goods for labor or other goods, rather than paying money
• Important information regarding employees, including names, social security numbers, and occupations
• Dates of employment
• Sick or vacation pay
• Copies of each employee’s W-4
• Payroll records of tax deposits
• Copies of tax returns
• Records of fringe benefits

Keeping payroll records is essential to maintain transparency and helps you stay clear of legal trouble. It also makes it easy for you to conduct a payroll audit.  

There may also be specific requirements for different business types. Additional records may be required for some payroll deductions or other tax documents. Employers have a few other recordkeeping and reporting responsibilities. One that’s important for new employers to be aware of is notifying the correct state agency when bringing a new employee on board. 

Should You Do Payroll Yourself?

Small business owners have lots of claims on their time, so sitting down to run payroll yourself may be a sacrifice. At the same time, it’s one of a business’s biggest expenses, so it can be nerve-wracking to put it in the hands of a payroll service.

However, payroll can be complicated and time-consuming, with several aspects and a multitude of requirements as you might’ve found out in the steps above. Running payroll is not like most other administrative tasks you’re able to pull along with your main work. It’s technical and requires undivided attention to be done properly.

Thus, it’s only natural to think about whether you should hire an in-house accountant to run payroll. This might be out of the question for smaller teams but larger businesses may want to give it a thought. But if you think your business can’t afford an accountant’s services yet, investing in reliable payroll processing software is a smart step. 

You Have to Familiarize Yourself with Federal & State Payroll Laws

If you’re running payroll on your own, you’re responsible for complying with all federal and state payroll laws. This includes important payroll laws like minimum wage rules in your city or state, worker’s compensation insurance requirements, final paycheck, and PTO payout regulations. 

You’re an entrepreneur trying to grow your business. Why slow yourself down trying to learn laws and regulations? Go for automated payroll software as they take care of all the legal requirements for you. You don’t need to study any laws since these payroll services take into account all federal and state regulations automatically.

Should You Use Professional Payroll Services?

A payroll provider is usually the more expensive payroll solution. However, you’re paying for a wider range of services. They’ll manage payroll calculations and file payroll taxes for an employer, of course, but may offer a number of other benefits as well.

What to Expect

With a payroll service, payroll processing is taken largely out of the employer’s hands. They’ll handle distributing employees’ paychecks, whether by direct deposit or another method, after calculating net pay. They’ll also pay payroll taxes and manage record-keeping. 

They may offer additional services that can help both you and your employees, such as advances on future earnings and making pay stubs available. You will have to pay more for the more elaborate features, however, which can quickly add up.

Benefits of Using Payroll Software 

Payroll software lets you pay your employees with ease. It takes care of everything from employee paperwork to filing taxes and frees up a lot of your time. Employees can enter their information on the software and it automatically calculates all taxes and benefits for each worker. All you have to do is run the payroll on payday, everything else is handled by the software. 

Payroll processing software comes in a wide variety of options. Some might be better thought of as a payroll system, doing a lot more than simply filling out tax forms. Examples include Quickbooks Payroll or Paychex. Other options are less complex and correspondingly less expensive. If you’ve got a small team with simple payroll needs, check out the best free payroll software.

You’re also likely to find industry-specific payroll software. For instance, we recommend restaurant owners use the best restaurant payroll software to manage payroll.

What to Expect

Even basic payroll software options help you process payroll and calculate deductions like state and federal taxes. A full payroll system automatically makes tax payments from your bank account and produces payroll reports at the end of each pay period. Software of that kind often comes with guarantees backing their tax calculations.

At this point, some software options are on par with a payroll service, both in terms of services and expense. Some software options may also offer full bookkeeping options, or integrate with bookkeeping software to make moving information easier. Higher-end options will even notify the correct state agency when you hire new employees.

Bottom Line on How to Do Payroll 

Every business owner should know how to do payroll manually, but that doesn’t mean they should do it that way. It’s good that you’re aware of the underlying processes but given the tons of time consumed by payroll processing, smart entrepreneurs automate it with payroll software.