When you’re running a small business, getting payroll right is as essential as it can be daunting. Even with the best intentions, you can make a number of errors that can impact your company, both financially and operationally.
Whether you handle payroll administration yourself, use an automated payroll software, or are on your way to outsourcing payroll, good payroll management starts with avoiding simple mistakes. Here are the 10 most common payroll errors we’ve seen small business owners make.
1. Not paying payroll taxes
This is one of the biggest and potentially most dangerous mistakes you can make with payroll.
In the United States, the government collects payroll taxes on a pay-as-you-go basis. There are a number of different federal, state, and local taxes which may or may not apply to your business. Missing deadlines on your payroll taxes can be a huge financial shock to your company.
Your payroll provider can help you figure out which taxes pertain to your business and can take care of the complexity of filing and paying the different tax agencies at the right intervals.
2. Misclassifying employees vs. independent contractors
When it comes to payroll compliance, employees and contractors are treated differently, especially where benefits and taxes are concerned.
Some states (such as California, Massachusetts, and New Jersey) apply stricter tests to distinguish between employees and contractors, so check the local laws where your workers are located to ensure you’re compliant. Also note that you generally need to file a 1099-NEC for contractors you pay $2,000 or more in a year.
Misclassifying a worker could be a violation of labor laws and also tends to have tax consequences, so confirm whether your worker is an employee or a contractor to stay compliant.
3. Confusing exempt vs. nonexempt status
The Fair Labor Standards Act (FLSA) regulates how employees are treated on a variety of work-related matters, including payroll. Employees are classified as exempt or nonexempt from FLSA requirements. It’s crucial to get this classification right in order to keep records and pay employees accurately—and to avoid penalties and back taxes for overtime that should have been paid to a nonexempt employee who was misclassified.
Nonexempt employees must be paid a minimum wage and receive overtime pay for hours worked after the base 40 hours/week has been met, and in some states (like California) overtime pay kicks in if a nonexempt employee works more than eight hours in a day.
To be exempt from FLSA requirements, a number of requirements must be met, including a minimum salary (federally, $684 per week, or $35,568 per year, though some states, like California and Washington, set higher minimums) and a job that is necessary for the business—but where success in the role isn’t tied to hours.
4. Choosing the wrong payroll schedule
How often you pay your employees can have a substantial impact on your operations and cash flow. It also impacts your employees. Your schedule sets how often you’ll need to collect hours, run payroll, and plan for payroll costs.
The most common payroll frequencies in the U.S. are weekly, biweekly (every two weeks), semi-monthly (twice a month), and monthly. State laws typically require a minimum pay period—you can always pay more frequently, but not less. Each pay schedule has advantages and disadvantages.
Refer to the guide below to help you choose the right payroll for your company and your employees.
Gusto guide on payroll periods
Monthly | Semimonthly | Biweekly | Weekly | |
|---|---|---|---|---|
Frequency (per year) | 12 months | 24 months | 26 (sometimes 27 weeks) | 52 weeks |
Payroll date | End of the month | Usually 1st & 15th or 15th & 30th | Every two weeks usually on Friday | Every week usually on Friday |
Hours per pay period (for hourly employees) | 173.33 | 86.67 | 80 | 40 |
Payroll processing cost | Lowest | Low | Medium-Low | Medium |
Implications to accounting | Lowest | Low | Medium-Low | Medium |
Implications to benefits | Lowest | Low | Medium-Low | Medium |
Processing time | Lowest | Low | Medium-Low | Medium |
Salaried employees | Salaried employees prefer being paid more frequently but the differences are minor. Most companies pay their salaried employees semimonthly or biweekly. | Salaried employees prefer being paid more frequently but the differences are minor. Most companies pay their salaried employees semimonthly or biweekly. | Salaried employees prefer being paid more frequently but the differences are minor. Most companies pay their salaried employees semimonthly or biweekly. | Salaried employees prefer being paid more frequently but the differences are minor. Most companies pay their salaried employees semimonthly or biweekly. |
Hourly employees | Lowest preference | Low preference | Preferred | Most preferred |
If you use payroll software like Gusto, it should help ensure that your schedule is convenient, consistent, and compliant.
5. Miscalculating pay
Payroll taxes can make it difficult to accurately calculate the gross or net payroll for your employees.
Gross pay isn’t always a simple hourly rate times hours. Commissions, bonuses, and overtime all need to be included, and commissions and bonuses are treated as supplemental wages that may be withheld at a different rate. When gross pay is miscalculated, it throws off every number that follows, from tax withholding to net pay.
Because of these taxes, the true cost of your employee is materially higher than the wages or salary you’ve offered them.
Understanding gross vs. net is an important component in budgeting for your business and understanding the cost of employing your team members. If you still have questions about how this is calculated, a Gusto team member can help.
6. Not providing pay stubs as required
There is no federal law that requires you to provide pay stubs to your employees, but most states do have their own pay stub laws. These laws include how you provide pay stubs (electronic or paper stubs), whether employees can opt-in or opt-out of electronic delivery, and what information must be included on the pay stub. Also—you guessed it—there are penalties if you don’t follow the rules.
7. Failing to gather the right paperwork and records
Even if you and all of your employees happen to reside in a state that doesn’t require you to provide pay stubs to your workers, the Fair Labor Standards Act (FLSA) requires you to keep accurate records about payments to nonexempt employees, including pay periods, dates and hours worked, and hourly rates, to name a few. The Department of Labor’s webpage keeps an exhaustive list of the records you need to hold onto.
It’s also important to gather all the necessary new hire paperwork, like W-4s and I-9s, to ensure that your employees are eligible to work in the United States and the correct information (like withholding tax) is entered on your payroll platform. Starting with the 2026 tax year, you’ll also need to separately report qualified tips and qualified overtime on employees’ W-2s (Box 12 codes TP and TT, plus Box 14b for tipped occupations) so they can claim the new federal deductions, so make sure your payroll system tracks both.
8. Making incorrect deductions and not fixing payroll errors
Deductions for taxes, benefits, and garnishments come out of every paycheck, and incorrect deductions are a common source of errors. Withholding too much or too little, applying the wrong benefit amount, or missing a court-ordered garnishment can cause trouble for you and your employees.
Errors also lead to overpayments and underpayment. If you underpay an employee, even by mistake, you generally need to make it right promptly, and some states add penalties for late wages. If you overpay, check your state rules before you deduct anything.
When you catch a mistake, make the payroll correction quickly and document it. Federal filings can be fixed with Form 941-X, and employees’ W-2s with Form W-2c. Fixing errors early is almost always easier than responding to a notice from a tax agency.
9. Skipping regular audits
Even careful teams can make mistakes. The best way to catch them is to perform regular audits of your payroll operations. Every quarter, compare your payroll reports against your tax filings and deposits, confirm each worker’s classification and pay rate, check that deductions match what employees elected, and make sure new hire paperwork is complete. Review your records whenever tax regulations or minimum wage rates change, too.
10. Relying on manual processes instead of payroll software
Spreadsheets and paper timecards can leave plenty of room for human error. Payroll software can use automation to take over the time-consuming parts of payroll administration, like calculating gross and net pay, withholding taxes, filing tax forms, and reminding you of tax deadlines. That cuts down on the miscalculations and missed filings described above. Look for a solution that handles tax filings and payments for you and keeps records you can pull up in an audit.
Avoiding mistakes now can save you money later
Payroll errors can become big problems quickly, but catching mistakes early is almost always easier and less expensive than responding to a notice later.
Luckily, most of these errors are preventable. Build regular audits into your routine, keep your records organized, and stay on top of changing tax regulations. If you’d rather not do it all by hand, payroll software can automate the calculations, filings, and reminders so you can focus on running your business.
FAQs
What are the penalties for paying payroll taxes late?
The IRS failure-to-deposit penalty runs from 2% to 15% of the unpaid amount, depending on how late the deposit is. It’s 2% for deposits up to five days late, 5% for six to 15 days, 10% for more than 15 days, and 15% if the tax is still unpaid more than 10 days after the IRS’s first notice.
Can you get payroll tax penalties removed?
Often, yes. The IRS may waive penalties through First Time Abate if you have a clean compliance record for the past three years, or through reasonable cause relief if you acted in good faith. Lack of funds alone generally doesn’t qualify. The IRS is also rolling out automatic penalty relief, so confirm current procedures.
What payroll taxes do employers have to pay?
Employers pay payroll taxes that match what’s withheld from employees: 6.2% Social Security (up to an annual wage base) and 1.45% Medicare. They also pay federal unemployment tax (FUTA) and state unemployment tax. FUTA is 6.0% on the first $7,000 per employee, but most employers get a credit that lowers it to 0.6%.
How long do you need to keep payroll records?
Keep employment tax records for at least four years, per the IRS. The FLSA requires payroll records for at least three years and time cards and wage-computation records for at least two. Some tax credit and leave records need six years, and state laws may require longer.
When are W-2s and 1099-NECs due?
W-2s and 1099-NECs for 2026 are generally due to recipients and the government by January 31, 2027. Because that date falls on a Sunday, the deadline moves to Monday, February 1, 2027. Employers send W-2s to employees and the Social Security Administration, and 1099-NECs to contractors and the IRS.
