Top 9 payroll mistakes, consequences, and how to fix them

Payroll mistakes can have huge consequences for business. They aren’t just annoying or frustrating—payroll mistakes can mean late or missed paychecks for employees, causing them to miss bills or suffer financially in other ways. And depending on the error (or errors), your organization could be on the hook for reimbursements, back pay, serious federal and state penalties, and even legal action. 

A recent IRS study found that 33% of employers make payroll mistakes. In 2023, the IRS assessed billions in collections and penalties. According to EY, the average business makes 15 corrections per payroll period, costing an average of $291 per error. That might not seem like a lot—until you consider the multiplier effect. The larger the organization, the higher the cost. In terms of lost time, EY’s survey shows that a company with 1,000 employees spends the equivalent of 29 workweeks fixing common payroll mistakes. 

In other words, it’s in every business’ best interest to avoid payroll mistakes at all costs. In this guide, we’ll look at the most common payroll mistakes, their ramifications, and how to fix (or avoid) them, saving your business time, money, and frustration. 

9 common payroll mistakes

Mistakes happen at various points in the payroll process. From misclassifying employees to submitting taxes incorrectly, these errors can have serious financial implications. Payroll mistakes also impact compliance with federal and state labor and tax laws, harm employee morale, hurt your organization’s productivity, and tarnish your image. These are some of the most common payroll mistakes: 

1. Misclassifying employees

There are two main areas where employees can be misclassified, and in both cases, there can be significant—and costly—ramifications. 

The Fair Labor Standards Act (FLSA) is a federal law that establishes a number of workplace-related regulations for private sector and government employees, including minimum wage, overtime, recordkeeping, and child labor protections. The FLSA is administered and enforced by the Wage and Hour Division of the US Department of Labor.

Employees are classified as either exempt or non-exempt. Non-exempt workers are not subject to some FLSA regulations (e.g., overtime, minimum wage), while other mandates still apply. Determining who is exempt is based on factors like job duties and salary.

Misclassifying workers under the FLSA can result in payroll errors and associated consequences, including financial penalties, retroactive overtime compensation, and potential civil penalties. 

Another common area of misclassification is whether a worker is an employee or a contractor. In this case, employers who misclassify their workers face IRS fines, interest penalties, and civil penalties. On top of that, there are legal consequences, which can include criminal fines, lawsuits, IRS and Department of Labor audits, damage to the company’s reputation, increased government oversight, and a negative impact on employee morale.

2. Miscalculating employee wages and hours

It’s your responsibility to pay your employees correctly. However, mistakes can and do happen. Failing to track hours and overtime correctly is a common error that can result in big problems. Fixing them is a time-consuming and frustrating process that can span several tax years and affect just a few employees or a large portion of your workforce. Underpaying or overpaying workers has tax implications, but if you’ve overpaid staff, you’re also faced with asking for that money back. That’s definitely not a morale booster. 

Miscalculating overtime is just one area of concern. Businesses must ensure compliance with labor regulations concerning work breaks, attending training programs, participating in functions outside standard working hours, and traveling for business purposes. 

Miscalculation of wages can happen for other reasons, too. These include poor record keeping (especially small businesses), failure to comply with federal, state, and local wage regulations, misinterpreting union scale, incorrect payroll deductions, errors in calculating pay for employees working either fully or partly on commission, and mistakenly paying employees on leave. 

These kinds of errors can result in a litany of consequences for the employer: 

• Paying back wages 
• Collecting overpayments from employees
• Federal and state fines and penalties
• Legal fees in the case of lawsuits
• Paying Damages
• Undergoing audits
• Reputational damage
• Criminal prosecution
• Managing frustrated employees

3. Having incomplete employee pay records

If you’re keeping records manually or trying to manage these records in addition to your regular role, you know how easy it is for errors to occur. Stacks of papers, multiple spreadsheets, and a rainbow of sticky notes do not make for an accurate and easy-to-use payroll management system. Mistakes get made, things get missed, and it can be a nightmare to track down errors to fix them.

Incomplete pay records can easily lead to serious problems like underpaying employees, tax withholding errors, and non-compliance with the recordkeeping provisions of federal and state labor laws. The FLSA requires employers to preserve three years of non-exempt employee payroll records, collective bargaining agreements, and sales and purchase records. Failure to do so can result in a fine of up to $10,000.

4. Missing deadlines

No matter the size of your business, you have obligations to meet. When it comes to payroll, you must pay your workers and file your taxes correctly and on time. Delaying employees’ pay—even just by a day or two—can have serious repercussions. It’s also not a good look for your company and can impact morale and increase turnover. That’s not considering the time and effort it takes to correct errors and run payroll late.

Missing federal, state, and local tax filing deadlines can lead to serious consequences, including late filing penalties, fines, interest charges, audits, and legal troubles. 

There are several reasons why a business may miss deadlines. Perhaps the biggest and easiest to fix is a disorganized payroll process. Other reasons include poor record keeping, cash flow issues, lack of dedicated payroll staff, and technical errors. 

5. Missing expenses

It’s easy to miss reimbursable employee expenses if they’re not documented properly in your payroll process. This could be due to manual data entry errors, employees filing their expenses late, or poor integration between your expense management software and payroll platform. 

The consequences of missing expenses include:

• Financial discrepancies
• Compliance problems
• Additional administrative burdens
• Disgruntled employees

6. Submitting the wrong taxes 

Submitting taxes incorrectly can happen because of human error, tax miscalculations, and misclassification of employees. As with anything dealing with taxes, these errors can result in serious troubles for your business. Regardless of the reason, you can still face significant consequences, including IRS penalties, interest, audits, and legal troubles, including criminal charges. 

7. Using incomplete employee information

Incomplete or incorrect employee records can also create headaches for your business. This can happen because of administrative oversights, failure to update employee information, or issues within your company’s onboarding process. As with other payroll mistakes, there can be serious knock-on effects, including misdirected payments and incorrect tax withholdings and filings.

These errors can require significant administrative work to correct, in addition to federal and state tax penalties, reputational damage, and potential legal complications. 

8. Misprocessing garnishments

Misprocessing garnishments is a payroll mistake that occurs when employers fail to properly manage court-ordered deductions from their employee’s wages (e.g., child support, tax levies, or creditor garnishments). These errors can be caused by data entry mistakes, inefficient payroll systems, miscommunication, or employers not knowing the rules for each garnishment type. 

Misprocessing garnishments can result in fines, legal action, extra administrative work, and other penalties, including financial costs to mitigate the error. 

9. Failure to report all forms of taxable employee compensation

Another common payroll mistake is failing to report non-wage compensation. Examples include bonuses, awards, stock options, and fringe benefits (e.g., personal use of a company car). These errors can happen due to misunderstandings, constantly changing tax regulations, manual or inadequate payroll processes, or lack of oversight. These mistakes can result in incorrect tax withholding, back taxes, fines, penalties, interest, or even criminal charges. 

Consequences of payroll mistakes 

Even a minor payroll mistake can result in significant consequences. In addition to the financial, productivity, and employee morale costs we touched on above, there are legal risks that come with payroll errors. Taking steps to prevent mistakes from occurring in the first place helps organizations maintain payroll compliance and avoid legal troubles. 

Tax penalties and fines

There can be hefty civil and criminal penalties for employers that make payroll errors related to taxes. Employers are legally required to collect and submit taxes withheld from their employees to the IRS. This includes federal income tax and social security and Medicare contributions (commonly known as Federal Insurance Contributions Act, or FICA taxes). The US Department of Justice’s Tax Division enforces tax law and takes it very seriously.

Unintentional errors can incur civil penalties, including:

• Fines based on a percentage of misclassified employees’ wages
• Fines for not paying FICA taxes 
• Penalties for failing to submit official tax forms like W-2s

Employers may also be on the hook for back pay and benefits that employees were entitled to. 

Criminal penalties for willful violations or tax evasion, including:

• Fines of up to $500,000
• Imprisonment 
• Legal costs 

In addition to federal penalties, employers may face state penalties, lawsuits, and ongoing audits. 

Back pay claims

Some payroll mistakes result in back pay claims from employees. These errors can result from data input or calculation errors, misclassifying employees, and incorrectly tracking hours and overtime.

Back pay claims can be sizable because they may include more than just owed wages. In some cases, the employer must also pay penalties imposed by federal and state regulatory agencies, damages, and legal fees.

Legal consequences can include lawsuits, Department of Labor investigations, and other penalties depending on the type and severity of the violations. In addition, employers have to shoulder the cost of finding and correcting errors, recalculating taxes and wages, and updating employee data and tax records. 

Corrective actions for labor law violation

Employers must take corrective actions after violating federal and state labor laws. 

First, the employer must stop the actions that led to the violations. After identifying the issue (assuming the violation was unintentional), the employer must remedy any harm caused. This could mean paying back pay and compensation for lost wages, benefits, and other financial losses employees may have incurred. They must also pay any fines, penalties, and legal costs determined by federal and state law.

The employer should work with tax and labor agencies to develop and implement a corrective plan and to take steps to prevent future violations. This might include instituting new policies and procedures for compliance, providing labor law training to managers and employees, and/or monitoring the payroll process to catch future errors or compliance issues. 

The employer may have to provide documentation to state and local agencies showing that they’re complying with any corrective orders they must take. 

How to prevent payroll mistakes and discrepancies: 4 Tips 

As we’ve seen, the fallout from payroll and compliance challenges is serious. Preventing them in the first place should be the goal of every business. By following these best practices, your organization can take significant steps toward avoiding costly errors and compliance violations. 

1. Establish clear payroll policies 

Establishing clear payroll policies for your organization keeps everyone on the same page. Create a reference manual containing your policies and outlining your payroll process. It should also include: 

• Guidelines for how to do employee payroll correctly
• Guidance for handling exceptions, errors, and other situations
• Procedures for reviewing and approving payroll changes, including approving and verifying adjustments
• Policies for records management and retention that comply with the FLSA and other applicable regulations 

Establishing your policies and procedures and addressing federal and state regulations can help keep you compliant and assist your employees if payroll problems occur.

2. Automate payroll processes 

Automating payroll is an effective way to reduce payroll mistakes. An integrated system that syncs with other HR functions can automatically perform key payroll tasks, from tracking hours and overtime to calculating and filing payroll taxes. With the right platform, you can run payroll quickly, minimize human error, and stay compliant. Sensitive data is more secure, and thanks to integration, you can easily create tailored workflows and custom reporting, all while preventing payroll mistakes.

3. Organize a payroll calendar

A payroll calendar provides an overview of your payroll process, helping you ensure timely and accurate employee payments. You’ll know at a glance when critical tasks need to be carried out, and it can alert you to important tax deadlines. Keeping on top of your obligations reduces compliance risks and late-filing penalties. A comprehensive payroll calendar can also work as a checklist, so you always know what’s been done and what needs to be done, helping to enhance your organization's payroll efficiency. 

4. Evaluate your payroll provider

If you’re experiencing recurring errors or inefficiencies with your current payroll process, it’s time to investigate why and resolve the problems. For companies running payroll manually, it could simply be that you’ve outgrown your process. This could be due to increased staff or because the complexities of paying your workers correctly and filing payroll taxes on time overwhelm a small payroll team (if you have one at all). If you’re already using a payroll provider and struggling with accuracy and compliance, you should consider switching services to a solution that better suits your needs. Switching to a new system can be daunting, so choose a provider that will work with you every step of the way. 

5. Follow payroll legislation updates

As the Greek philosopher Heraclitus once said, “Change is the only constant in life.” When it comes to federal, state, and local labor and tax laws, Heraclitus hit the nail on the head. Businesses have to comply with a multitude of ever-changing regulations. You have to keep up with updates to existing laws and legislation, like minimum wage, paid time off (PTO), and tax withholding. You must also learn and institute new government policies and programs as they roll out. If you’re not keeping up with these constant changes, you’re opening the door to payroll errors, costly compliance issues, and legal troubles.

How to fix payroll mistakes

Payroll mistakes happen. Unfortunately, they can be incredibly hard to fix, especially if you’re dealing with numerous errors affecting multiple employees over several months or years. The steps you need to take depend on the type(s) of errors and their impact on your workforce. Let’s look at some of the most common unintentional payroll errors and how to deal with them. 

Misclassifying employees

As noted above, misclassifying workers (e.g., independent contractors or employees) can result in severe repercussions, including financial penalties, back pay, tax recalculations, and civil penalties. Upon discovering a case of misclassification, these are the general steps that you need to take:

1. After identifying the misclassification, review your records (e.g., job descriptions, work arrangements) to determine if the misclassification is an isolated case or more widespread. 

2. Reclassify the worker(s) correctly and inform them of changes to their status, wages, and entitlements. Advise federal or state agencies, if required. 

3. Calculate back pay, unpaid overtime, benefits, and any other compensation you may owe the worker. 

4. Update your payroll records. 

5. File amended tax returns and any additional forms or documentation required by the IRS and state agencies.

6. Pay any outstanding taxes. 

7. Investigate how the error happened, review company policies and procedures, and take steps to prevent misclassification mistakes from happening again.

Missing tax deadlines

The consequences of missing tax deadlines can add up quickly, so immediate action is necessary to mitigate this common payroll error. 

1. File any outstanding tax forms and required payments immediately. This will help reduce the amount of potential fines and penalties. 

2. Calculate and pay any penalties and interest you owe. 

3. Advise the IRS of any under or overreporting of payroll taxes and submit any required documentation and official forms. 

4. Audit your payroll process to find the source of the error and correct it.

5. Take preventative measures to avoid missing tax deadlines in the future. This could be as simple as setting up a calendar with reminders. A more robust solution is to use payroll software to help prevent errors and flag potential issues.

Miscalculating employee wages and hours

As with all major payroll mistakes, prompt action is required. If you’ve miscalculated employee wages and hours, follow these steps:

1. Identify and verify the error immediately. 

2. Determine the correct amount of pay that the employee should have received.

3. Notify the employee of the error and explain your plan to correct it. 

4. Make the required adjustments to the employee’s pay. 

5. Recalculate tax withholding amounts and update your records.

6. Correct the employee’s pay in the next payroll run or do a manual run if required.

7. Take steps to prevent the error from happening again. 

8. Record the steps taken to mitigate the error. 

9. Consider using payroll software to avoid similar mistakes in the future. 

Keep in mind that the steps above are general in scope. Resolving payroll issues can be far more time-consuming and costly, depending on your circumstances. 

Preventing errors in the first place is the best solution to payroll mistakes. An automated payroll system like Rippling can help you stay compliant and reduce your risk of human error by automatically calculating your payroll taxes, deductions, and employee wages and hours with a 100% error-free guarantee.

Easy and mistake-free payroll with Rippling

If you want payroll so powerful it runs itself, you want Rippling. With a 100% error-free guarantee, compliance automation, and endless configurability, Rippling runs payroll in minutes—so your teams can focus on other priorities. You just click “Run" and Rippling automatically tracks hours, calculates wages, withholds payroll taxes, and files them with the right federal, state, and local agencies at the right time, every time. 

Rippling offers full-service payroll that’s built on top of a single source of truth for employee data. That means your employee data isn’t tied to one specific app—it’s the same across payroll, time and attendance, onboarding, performance management, and any other apps you use within our unified platform. 

What does that mean for you and your team? For starters, you have a single source of truth for up-to-the-minute employee information. It also means that your team doesn’t have to reenter information across systems when an employee gets promoted or moves to a different city to work remotely. From changing security permissions to updating PTO policies, Rippling triggers automatic updates to employee information in a single flow. This is especially beneficial for small businesses. It allows you to do more with less—less money, less headcount, and less time. And all with a 100% error-free guarantee.

Payroll mistakes FAQs

How much time and resources are lost due to payroll mistakes?

According to the IRS, one-third of US businesses make payroll mistakes every year. In addition to financial costs and reputation damage, businesses waste countless hours tracking down and rectifying payroll mistakes. According to a recent EY report, employers can spend up to 26 minutes per employee correcting each payroll discrepancy.

How long does a company have to correct a payroll error?

While no federal laws mandate a specific time frame for correcting payroll errors, employers are expected to fix mistakes promptly. Some states, like California, may add “waiting time penalties” for extended delays.

What happens if an employee refuses to pay back an overpayment?

The FLSA and most state labor regulations give employers the legal right to recoup overpayments. Employers can do this by deducting the amount from future paychecks. However, this can vary depending on the state. Some states require employee consent, while others restrict timeframes. Depending on location and circumstances, an employer may be able to sue to recover the funds, use a collection agency, or garnish wages. Note that courts generally expect employers to be reasonable when recovering overpayments.

Who is responsible if an employer makes mistakes with payroll?

In the US, the employer bears legal and financial liability for any payroll errors or mistakes, even those caused by individual employees, departments, or external payroll processors.

This blog is based on information available to Rippling as of September 25, 2024.

Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.