Sense with Cents

Payroll mistakes are cheapest to fix while the books are still open. After that, they come with paperwork.

The first rule of fixing payroll mistakes is the obvious one: do not make them. Check the hours, check the rates, check the setup before the check goes out. My rule (and I break it from time to time, like any human) is to enter the payroll, print a check listing, and look it over. Compare it to past averages, initial the net on every check, and sign and date the review, noting what was looked at. That alone will catch most big errors. Maybe it is the review, maybe it is someone having to put their initials on it, maybe both.

The second rule is the honest one: mistakes happen anyway. A wrong rate, a missed deduction, a benefit set up as taxable when it should not be, or the other way around. The goal is not a perfect record. It is catching mistakes while they are still easy to fix.

My own most recent one: an employee worked seven days in a row in the same workweek. In California, the seventh consecutive day of work in a workweek triggers overtime, even when no single day ran longer than three hours. I missed it. The employee missed it. I finally caught it on a quarterly review, which is exactly why I do them.

One more habit: you do not have to check the same things every time. What works for me is focusing on a couple of different things each payroll. Eyes that look for the same thing every week stop noticing everything else.

Fix it while it is still open

Payroll reporting runs on two clocks: the quarter and the year. Each one closes when its return is filed. What matters most is fixing a mistake before its clock runs out.

Best: the same quarter. If the quarter’s returns have not been filed yet, a mistake can usually be corrected on a later paycheck in that same quarter. The quarterly return then reports the right numbers the first time, and nobody outside the business ever knows.

Next best: the same year. Once a quarter is filed, a mistake from it technically belongs on an amended quarterly return, though in practice many are handled differently (more on that below). But the W-2s have not gone out yet, so the year-end numbers can still come out right, and the employee never gets a corrected W-2.

What to fix, and how

This is where payroll becomes more art than arithmetic. Some fixes belong naturally on the next paycheck. Missed pay, like my seventh-day overtime, is simply paid when it is caught and reported in the quarter it is paid. Other fixes, like a deduction taxed the wrong way back in the first quarter, technically belong to the quarter where the mistake happened.

In the real world, most small businesses that find a first-quarter mistake fix it in the second, third, or fourth quarter instead of amending the first. Is that perfect? Probably not. It is what most do, and in my experience it rarely causes major issues, as long as the year’s totals come out right on the W-2. The textbook fix is an amended return, and some advisors insist on it. If yours does, follow their lead. If the mistake is large, ask before you fix it.

This is where the art comes in: the perfect fix, the practical fix, or something in between. For many businesses, it comes down to dollars. One might decide that anything under $500 gets fixed on a current paycheck, accepting the risk of a future penalty on those smaller amounts. That is an internal policy, not a rule, and it is theirs to make.

A note on scope: when a mistake means an employee was underpaid, many states add their own penalties and deadlines for making it right. Those vary too much from state to state to cover here. This post is about preventing mistakes, and correcting them while the year is still open.

Two good times to look

Every year, right around the end of the third quarter, I send customers a reminder to review their payroll work for the year so far. The timing is on purpose.

By the end of September, most of the year’s patterns are set. A rate that is off, a deduction set up the wrong way, or a new employee entered with the wrong state all show up clearly in nine months of history. And there are still three months left to clean it up while the year is open.

Wait until December, and the same review turns into a race against W-2 season. Wait until January, and the easy fixes are gone.

I suggest a second look after the next-to-last payroll of the year. That leaves one more paycheck to absorb any fix before the year closes. In my own case, I have an insurance benefit whose cost changes every March. It does not change the paycheck, but it does show up on the W-2, so each December I compare what was recorded against what was actually paid, and clean up the difference so the W-2 is right.

Neither review needs to be fancy. Set aside a few minutes and look for what jumps out: glaring issues, numbers that look strange, a paycheck count that does not match how often the employee was paid. You are not auditing every line. You are looking for the things that are easy to spot, because those are also the easiest to fix while the year is still open.

A bit of common sense helps decide where to look. On paychecks, focus on mistakes that put more money in the employee’s pocket. In my experience, employees will let you know quickly if they should have received more. They are much less likely to mention getting too much. That said, do not ignore underpayments. The employee may not notice every one, and they can be costly to fix later.

One more step I add: at each review, pick one or two employees at random and look at their check history for the year. Count the checks. Look for one extra or one missing, and anything else that catches your eye. Rotate through so every employee gets a turn at some point during the year, and look over the full year’s check listing before and after the last payroll of the year. In Medlin Payroll, a single report covers it: the Payroll Check Listing for the year. When that listing is correct, the paychecks are correct, and everything built from the paychecks will be correct too.

The one to get right the first time

If there is one place to spend extra effort, it is the W-2. Quarterly returns go to agencies. The W-2 goes to a person, who uses it for their own finances.

Picture an employee who files their tax return the day the filing window opens. A few weeks later, a corrected W-2 arrives, and the change is enough to make a $200 difference on their return. Now they have to file an amended return of their own, maybe pay someone to do it, and wonder why their employer got it wrong. They may or may not ask you to cover their extra cost. Either way, it is not the conversation you want to have in February.

A mistake on a quarterly return is a business problem. A mistake on a W-2 becomes the employee’s problem too.

When it is already closed

Sometimes a mistake surfaces after the quarter or the year has closed. That is what the “X” and “C” forms are for. A 941-X amends a filed quarterly return. A W-2c corrects a W-2 that already went out. Most states have their own versions of both.

These forms are not a disaster. They are also not fun. Each one takes time and can bring interest or penalties along with it. That is the whole case for catching things earlier.

If you are already past that point, the same calm approach applies. Figure out what went wrong, correct it the right way, and fix the setup so it does not happen again. The mindset from There Is No Such Thing as a Payroll Crisis fits here too.

The takeaway

Do not make mistakes. When you do, fix them while the quarter is open if you can, and while the year is open if you cannot. The later the fix, the more paperwork comes with it. Paperwork is an expense, in time and in money, which in a small business are the same thing. And sometimes the late fix brings penalties and interest along for the ride.

One more thing to keep in mind. Whether you run your own payroll or hire it out, you cannot buy your way out of the responsibility. The employer is ultimately responsible for its own payroll liabilities, every time, in every case. A payroll service can do the work, and may even cover the cost of its own errors, but the agencies still look to the employer. (More on that choice in DIY Payroll vs. Payroll Service.)

If you are reading this near the end of September, this is your reminder. Review the year so far while there is still time to make it right the easy way, and put a second look on the calendar for after your next-to-last payroll.