The 6 most common payroll mistakes (and how to avoid them)

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Running your business is a lot of work. The last thing you want to worry about is 01_ 04_ a costly mistake from an accounting or How do you maximize your tax deduction Is accrual or cash accounting best for payroll related misstep. This is important and minimize tax exposure? your business? because with all the complicated rules and regulations, a lot can go wrong. 02_ 05_ We worked with leading accounting How frequently should you pay and file How do you avoid misclassifying software provider FreshBooks and taxes to avoid tax penalties? employees and contractors? identified the six most common accounting and payroll mistakes that can cost your business. 03_ 06_ Knowing where the pitfalls are is just the How do you manage receivables to get What payroll and accounting reports do first step. In this guide, we’ll also provide cash back into your business? you need to keep on file? you solutions and best practices so your business won’t fall into those traps.

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How do you maximize your tax deduction and minimize tax exposure?

www.gusto.com | 1 (800) 936–0383 A common mistake for most the receipt is unclear, and end up triggering small business owners is the an audit. mismanagement of expense Even if you’re confident you’re safe on taxes, tracking, particularly when it poor expense management means you have comes to receipts. How often poor insight into your company’s spending. do you find yourself asking: Rather than wait until tax day to organize Customer story your expenses, you should consider tracking I’ll take care of these receipts when them as close to real-time as possible to Your business requires a lot of travel I prepare my tax return. better manage your company’s day-to-day and you take taxis frequently. Rather Unfortunately, this is a common operations. than wait until tax time to see the mistake made by novice and seasoned impact of your travel expenses, use entrepreneurs alike. Receipts can become an online accounting vendor. This Consider using an automated service faded and unclear, or even worse, lost. way, you can sync your expenses to provider to track your expenses as your reporting software and track The impact on your business can be very they come in. With a provider like your expenses in real time. meaningful, particularly around tax time. FreshBooks, for example, you can Without proper expense management, import prior expenses from your credit you may miss expenses on your tax return, card or bank accounts. which means fewer deductions. You may also mis-categorize an expense because

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How frequently should you pay and file taxes to avoid tax penalties?

www.gusto.com | 1 (800) 936–0383 As an entrepreneur, taxes are probably the last thing on your mind until April. You may think:

I’ll reconcile my tax payments at the end of the year.

But it turns out you may have to pay payroll-related taxes year-round. The IRS and each state regulate your tax payment schedule, and the schedule differs between each state. Customer story The frequency of your tax payments also depends on your payroll frequency (e.g., monthly, biweekly). 40% of small businesses get fined an average of $850 per year for improperly Your business pays monthly payroll paying their payroll-related taxes so this is not a small concern. for most of your employees and semimonthly for others. Rather than It’s important to pay attention to IRS and state notices mailed to you year-round. Each state pay taxes according to the employee’s has its own set of regulatory bodies for payroll tax compliance. pay period, you pay taxes monthly for everyone. Because you are not On the following pages is the complete list of state governing bodies for labor and payroll: matching your taxes based on pay period, you may be at risk for tax penalties. To protect your business, outsource your payroll to a third-party provider.

www.gusto.com | 1 (800) 936–0383 ALABAMA CONNECTICUT IDAHO Dept. of Labor Dept. of Labor Dept. of Labor Dept. of Revenue Dept. of Revenue Services State Tax Commission

ALASKA DELAWARE ILLINOIS Dept. of Labor and Division of Revenue Dept. of Employment Security Workforce Development Dept. of Labor Dept. of Revenue Dept. of Revenue DISTRICT OF COLUMBIA IOWA ARIZONA Dept. of Employment Services Dept. of Revenue Dept. of Economic Security Office of Tax and Revenue Workforce Development Dept. of Revenue

FLORIDA KANSAS ARKANSAS Dept. of Economic Opportunity Dept. of Labor Dept. of Finance and Administration Dept. of Revenue Dept. of Revenue Dept. of Workforce Services

GEORGIA KENTUCKY CALIFORNIA Dept. of Labor Career Center Dept. of Industrial Relations Dept. of Revenue Dept. of Revenue Employment Development Dept. Franchise Tax Board HAWAII LOUISIANA Dept. of Labor and Industrial Relations Dept. of Revenue COLORADO Dept. of Taxation Workforce Commission Dept. of Labor and Employment Dept. of Revenue

www.gusto.com | 1 (800) 936–0383 MAINE MISSOURI NEW MEXICO Dept. of Labor Dept. of Labor Dept. of Workforce Solutions Revenue Services Dept. of Revenue Taxation and Revenue Dept.

MARYLAND MONTANA NEW YORK Dept. of Labor Licensing & Regulations Dept. of Labor and Industry Dept. of Labor Comptroller of MD Dept. of Revenue Dept. of Taxation and Finance

MASSACHUSETTS NEBRASKA NORTH CAROLINA Dept. of Revenue Dept. of Labor Dept. of Labor Labor and Workforce Dev. Dept. of Revenue Dept. of Revenue

MICHIGAN NEVADA NORTH DAKOTA Dept. of Licensing and Regulatory Affairs Dept. of Employment, Dept. of Labor and Human Rights Training and Rehabilitation Dept. of Treasury State Tax Commission Dept. of Taxation

MINNESOTA OHIO NEW HAMPSHIRE Dept. of Employment and Dept. of Job and Family Services Dept. of Labor Economic Development Dept. of Taxation Dept. of Revenue Employment Security

OKLAHOMA MISSISSIPPI NEW JERSEY Employment Security Commission Dept. of Employment Security Dept. of Labor and Tax Commission Dept. of Revenue Workforce Development Division of Taxation

www.gusto.com | 1 (800) 936–0383 OREGON TEXAS WASHINGTON Employment Dept. Workforce Commission Dept. of Labor and Industries Dept. of Revenue

UTAH PENNSYLVANIA WASHINGTON DC Dept. of Workforce Services Dept. of Labor and Industry State Tax Dept. State Tax Commission Dept. of Revenue Workforce West Virginia

VERMONT RHODE ISLAND WEST VIRGINIA Dept. of Labor Dept. of Labor and Training Dept. of Workforce Department Dept. of Taxes Division of Taxation Dept. of Revenue

VIRGINIA SOUTH CAROLINA WISCONSIN Dept. of Taxes Dept. of Employment and Workforce Dept. of Workforce Services Dept. of Labor Dept. of Revenue

SOUTH DAKOTA Dept. of Labor and Regulations

With all these state regulations, it may be a challenge to stay compliant.

TENNESSEE Fortunately, a full-service payroll provider like Gusto should manage these Labor and Workforce Dev. tax payments so you don’t have to.

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How do you manage receivables to get cash back into your business?

www.gusto.com | 1 (800) 936–0383 As a business operator, you may may invoice your customer the wrong be too busy selling your product amount. Or you may forget to bill them and forget about collecting on your entirely! receivables. It’s easy to just think: To protect yourself from cash shortfalls due

If I just focus on getting customers and to poor invoicing, consider using an online delivering good service, my business will vendor to automate the process. A vendor Customer story succeed. can help you: Your business provides a minor Invoice as soon as the project is finished But a lengthy Days Sales Outstanding service for a customer and you send an invoice shortly after. Because you (DSO) means you’re extending a lot of Track the work throughout the did not have any systems in place to credit to your customers and not collecting engagement cash quickly enough. This means you’re remind yourself of the outstanding leaving your balance sheet exposed to cash Automate follow-ups, especially if payment, you forget and you don’t shortfalls. In addition, invoices can come at payments are late collect. an unpredictable rate. If you’re not matching Accept payments online your revenue with your expenses as they come, you can hit working capital issues. Create an online paper trail for clients and regulators Without proper invoicing, your business is open to costly mistakes. For example, you

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Is accrual or cash accounting best for your business?

www.gusto.com | 1 (800) 936–0383 There are two types of accounting Accrual accounting: This type of accounting methods: cash and accrual recognizes revenue and expenses when they accounting. You may wonder: are earned, regardless of when cash is pa id in or out. My business is too small for my accounting methods to have any impact. Customer story Actually, which method you choose can have a meaningful impact on visibility into Your business is growing quickly so your business operations. Your accounting you decide to hire a team member method can provide direct insight into to build out your FP&A group. Since the financial health of your business and you’re looking to project P&L, you inaccurate accounting can lead to fines. decide to switch from cash accounting to accrual accounting. First, let’s define the two methodologies:

Cash accounting: This type of accounting recognizes revenue when cash is received and expenses when cash is paid out. Under this method, there is no accounts receivable or payable.

www.gusto.com | 1 (800) 936–0383 Here is a breakdown of the pros and cons of these two methods across different criteria:. Which method should you adopt? While most small businesses start with cash accounting, as companies grow, they adopt accrual accounting because it better monitors a company’s long-term financial health. It also follows accounting’s matching principle.

A wrong selection may cause a serious problem for your business. For example:

Under accrual accounting, your business reports revenue before receiving actual payment, and you are short on cash this week or month.

Under cash accounting, you don’t have a clear view on your company’s growth because you only report revenue when cash comes in. You end up under-investing in your fast growing business.

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How do you avoid misclassifying employees and contractors?

www.gusto.com | 1 (800) 936–0383 Using a contractor is a great way Use this guide to check to see if your worker to bring additional help to your is a contractor or employee. (use same business. But are your properly content as before) classifying your worker? Do you catch yourself asking:

I only use contractors infrequently so I Customer story shouldn’t have to worry about the rules. Your company needs help so it hires

Misclassifying your worker can be a a designer to work on some projects. costly mistake on multiple fronts. If your This designer starts out working contractor is actually an employee, you may from home but as projects ramp be underpaying payroll taxes. On average, up, you bring the designer into the employees can cost 25-30% more than office. The designer starts coming contractors. in for regular hours, and works on a laptop set-up used by other full-time In additional, nearly 30% of employees employees. Your worker may now be are misclassified as contractors. Your an employee instead of a contractor. business could face serious legal and financial penalties as states and the federal government are cracking down on labor abuses.

www.gusto.com | 1 (800) 936–0383 Employee vs Contractor

Before you make this important staffing decision, you need to fully understand both types of workers and the importance of classifying them correctly. Failing to do so could cost your business.

If you are still unclear, complete IRS Form SS-8 and they’ll give you a final determination of the worker’s status. It could take 6 months for a decision, but it will give you peace of mind to continue running your business.

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What payroll and accounting reports do you need to keep on file?

www.gusto.com | 1 (800) 936–0383 After avoiding all these potential Optionally, you can choose to verify the Marital status mistakes, it’s tempting to think employee’s work status online using e-Verify. The number of allowances claimed on you’re done without proper Form W-4: Your employee will also need the W-4 reporting: to fill out FormW-4 to determine their tax Compensation (Note: This may depend on withholding (Note: You cannot do this on I filed the proper forms, I’m done! the State where your employee receives their behalf). The W-4 does not need to be payroll.) Actually, good reporting can help you submitted anywhere, but each company is manage your business or help you avoid legally required to keep every employee’s Employees who anticipate a full refund may costly legal fines. For payroll, you are legally W-4 on file for a minimum of four years. Only be exempt from withholding. This is different obligated to keep certain documents on file: modern payroll providers like Gusto manage from employees who are exempt, like clergy your withholding taxes on behalf of you and or certain visa holders. Form I-9: Each employee needs to fill out your employee. Form I-9 to verify he or she is legally eligible to work in the US. You don’t need to submit A withholding tax is a pay-as-you-go tax to the form, but you must keep it on file (a the IRS and can be calculated through the digital copy works just fine) for the entirety of W -4 and their IRS withholding calculator. the employee’s employment, and a minimum These three things determine how much you of either 3 years from the hire date or 1 year withhold for your employee: from the term date, whichever is longer.

www.gusto.com | 1 (800) 936–0383 New hire reporting for states: Each state How much have I spent, and on what? has a department to report your new hires. What work will I be able to bill for soon and You will typically provide the employee’s for how much? name, address, and social security number.

Depending on the state, you may have To monitor these metrics, create the following anywhere between a few days to 90 days to reports with modern accounting software like submit this information to the state. Check FreshBooks: Customer story your local state tax, labor, and workforce Your company has multiple clients website for more information. In California, Accounts receivable aging: This report and your collections team does for example, an employee has to file aDE-34 . helps categorize your accounts receivable not have a clear outlook on aging Fortunately, your payroll provider should based upon the length of time of the of certain invoices. Use a modern be able to file documents like the DE-34 outstanding invoice. accounting software provider to automatically on your behalf. Expense report: It’s important to have monitor your accounts receivable Reporting and metrics: In addition, good an itemized and categorized report of aging and other important financial reporting can also give you visibility into your your expenses for both budgeting and tax metrics. business finances. The metrics you want to reporting purposes. track include: Profit and loss (P&L): The P&L statement Which invoices are outstanding, and how is a summary of your revenue, expenses, old? and profit over a period of time. It is sometimes called an income statement too.

www.gusto.com | 1 (800) 936–0383 Let us help you Now that you identified these common accounting and payroll mistakes, it’s important to Join Gusto work with SaaS partners like FreshBooks and Gusto who can handle these problems for you. With Gusto, we designed our software so that business owners are prevented from today! making mistakes when possible. This way, you don’t have to worry about payroll and you can continue growing your business. Get your first two

For more information on how Gusto can help you, check out the following resources: months free.

Gusto blog: This is our ongoing corporate blog that covers the latest small business best practices, updated multiple times a week.

Gusto FAQ: We answer some of the most common questions about our payroll software and its features.

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