When it comes to paying payroll, small and medium-sized businesses generally have more challenges than larger corporations, and therefore make some common compliance mistakes when it comes to filing taxes. They often have smaller HR teams and limited support, which can make staying on top of tax rules and regulations overly difficult. 

However, businesses (whether they are big or small) cannot afford to make common compliance mistakes. Even the smallest error can result in costly penalties, interest charges, or even tax audits. Therefore, it’s important for companies to protect their business by ensuring they are compliant with current payroll issues. 

In this article, we’ll share some of the most common mistakes that SMBs make and what they can do to avoid them in the future!

6 Common Compliance Mistakes for SMBs 

1. Misclassifying Employees

One of the most common (and unfortunately, most expensive) mistakes for an SMB is misclassifying its employees. For example, “freelancers” who work full-time and use company equipment should normally be classified as employees. But many companies hire them as contractors in order to avoid paying payroll taxes. 

Misclassifying employees as independent contractors can lead to costly penalties and compliance issues. Paycor provides payroll and HR tools that help businesses properly categorize workers, track documentation, and stay aligned with evolving labor regulations to reduce risk and administrative errors.

If audited, your business may be required to pay back those taxes. And you may also be liable for unpaid overtime, penalties, or even legal fees caused by the misclassification. Therefore, it’s crucial that businesses follow labor laws and IRS guidelines when classifying employees for payroll. 

2. Not Reporting Overtime

If you have employees working overtime, these extra hours need to be properly tracked and paid. While this mainly applies to retail or hospitality workers, it may impact all types of SMBs. This is especially true if you have employees with irregular schedules or who work from home.

To avoid any penalties or fees associated with underreporting, companies should invest in real-time tracking software. That way, they can keep tabs on employee hours and ensure they are complying with overtime payments while also reducing the chance of manual errors. 

3. Missing Tax Deadlines

Even if your company files everything correctly, you still may end up making this one common compliance mistake – missing your tax filing deadline! Payroll tax deadlines are strict, and missing one by just one day can trigger fees or accrue interest. And if those are left unpaid, you may end up owing thousands of dollars to the IRS for something that could have been easily avoided.

But there’s an easy way to prevent this. Simply set automated reminders for upcoming deadlines. And don’t just set alerts for federal taxes. Most businesses are also required to pay state and local taxes too.

4. Submitting Incorrect Tax Withholdings

As you might imagine, submitting false or incorrect tax information can result in major penalties if your company were to be audited. And that’s on top of the money you’ll owe for underreporting employee statuses. So when employees update their W-4, it’s your responsibility to ensure these changes are made on your business taxes. 

5. Not Keeping Accurate Records

As your company grows, it can become increasingly more difficult to manage payroll for your employees. But not keeping accurate records is one of the most common compliance mistakes. That’s why we recommend using payroll reporting software to keep track of your internal operations.

If you don’t have detailed reports for hours worked, breaks taken, or overtime, then you won’t be able to dispute anything if audited by the IRS. As a result, you may be asked to pay back assumed wages (even if employees were paid correctly), not to mention fines and additional legal costs.

6. Overlooking Laws

All businesses are required to abide by federal, state, and local laws. That includes paying things like minimum wage, sick leave, overtime, etc. Failing to do so isn’t just unfair to your employees, but it also puts your company at risk for financial penalties and legal disputes. Keeping track of laws and adhering to them can help you completely avoid making common compliance mistakes.

To prevent common compliance mistakes from happening, make sure you stay informed about local laws and regulations. If your business has multiple locations, you may have different state or local laws you’ll need to adhere to. Working with a payroll specialist or tax professional can also help you stay compliant.

The Cost of Common Compliance Mistakes for SMBs

While these compliance mistakes are expensive for any business, they can be particularly damaging for small and medium-sized businesses. One small oversight can quickly turn into thousands, or even tens of thousands, of dollars in expenses. To put this into perspective, let’s take a closer look at the potential costs involved.

First, there are the fines and penalties. Depending on the severity of the mistake, your company may be charged anywhere from $50 to $5,000+ per violation. This can be even higher if this has been a recurring mistake for your business. There are also interest charges, as unpaid taxes generally accrue interest over time. Not paying these fees on time can also cost between $100 to $5,000. 

Then there is back pay. If you’ve underreported on your taxes, you may need to pay those extra costs retroactively. For many businesses, this can be anywhere from $1,000 all the way up to $25,000. And what happens if litigation is required? Hiring a lawyer or attorney can be extremely expensive (we’re talking a minimum of $10,000 per case!). 

All of these don’t even take into consideration the internal cost of dealing with these issues. The time spent fixing these mistakes and dealing with auditing issues pulls focus away from an employee’s day-to-day tasks, which can slow down operations.

Related: Continuous Compliance Monitoring: Leverage Tech to Stay Regulator- Ready 

Don’t Make These Common Compliance Mistakes

Making common compliance mistakes on your payroll may seem like a small issue, but for SMBs, the costs can be high. As such, it’s important for your team to stay informed and regularly review your payroll processes in order to avoid these common compliance mistakes. Start planning how to keep ahead of these common compliance mistakes now so your future filing can go smoothly!