For many small businesses their biggest challenge is finding qualified employees who will show up on time and perform an honest day’s work. Staffing choices have the potential to either make or break a business. Employment relationships can be difficult to manage, and by their nature, involve a certain amount of risk. Keeping track of payroll regulations and deadlines can seem overwhelming.

To make it all a bit more confusing, some commonly accepted payroll practices are actually illegal, and leave the employer exposed to serious legal and financial consequences. But misinformation isn’t a valid excuse for employers; they have a legal obligation to clearly understand the rules.

Most of these misconceptions start right with the hiring process. Here are three common payroll pitfalls employers should beware of.

The Trial Period

How many times have you heard: “We’ll give the new person a trial period. The candidate will come in for a few [hours, days, weeks] to see how it all works out, and if both parties are happy at the end of the trial period, we’ll make it formal.”

What is the problem here? It sounds uncomplicated and open-ended, but is it really that straight forward? How will this worker be paid during the trial period? As an employee? Or as a subcontractor? If your answer is subcontractor, you need rethink your hiring practices.

Once someone starts working at your business under your direction, they are automatically an employee. It doesn’t matter if they work for you an hour, a day, or a week. They become eligible for all the rights and protections that employees are due.

If you as the employer don’t follow the rules, they can legitimately report you to any number of government agencies if they are not happy with how the relationship turned out. If you don’t have your paperwork in order, these agencies usually side with the employee.

Paying a Flat Rate

Here’s another common misconception: “We have agreed on a flat weekly rate. It will be easier that way. We won’t have to track hours and won’t have to pay overtime.”

Sounds good, especially if both parties agree, but is it a legitimate salary arrangement? Federal and state employment rules are very strict as to what kinds of jobs are allowed to be salaried without overtime, and what a minimum salary should be. Before making an employment offer, check that your compensation agreement conforms with payroll laws.

No matter what the parties agree to, it won’t be binding if it is against the law. If a disgruntled former employees demands overtime pay for periods of past employment, an illegitimate salary arrangement could become very costly to the employer.

Find out more about overtime and salaried employee exemptions at the US Dept of Labor website.

Misclassifying Employees as Independent Contractors

A third misconception is: “The person I hired agreed to be paid as an independent contractor, instead of an employee, so there’s no need to put them on payroll or take out taxes. It will be easier that way.”

Using subcontractors and freelancers instead of employees can be beneficial in many circumstances. But keep in mind that classification of employees is determined by a combination of factors. Among other requirements, an independent contractor needs to be truly independent and separate (providing their own tools, setting their own schedule, etc). If that’s not the situation, then they should be considered employees, no matter what the parties involved would prefer to call the relationship.

Many businesses choose to blur the lines between employees and subcontractors for their own convenience. Doing so can eventually result in serious issues with the government agencies that oversee employee relationships. Having independent contractors reclassified as employees would be very expensive and painful learning experience.

You can download IRS publication 1779 to review the basic guidelines for classifying subcontractors and employees.

How to Avoid the Pitfalls

Volumes have been written about employee relations and payroll regulations. But here are three basics steps every employer should take when hiring:

Know who you are hiring. Conduct a formal interview and make sure to check references. Choosing the right person isn’t so much about the talent of the person as their integrity. Skills are much easier to teach than values.

Make sure all the necessary paperwork is in place before employees start. That includes the Federal W-4 and state withholding forms along with the I-9, which requires the employer’s signature, confirming the identifying documents provided by the employee.

Provide employees with written job descriptions detailing their responsibilities, the agreed compensation, and their work schedule. Make sure they are familiar with the employee manual. Having everything in writing helps avoid serious misunderstandings and will make it easier to enforce company policies if necessary.

Payroll comes with its own set of requirements and deadlines. There are a plethora of government agencies actively regulating the payroll process; the employer who chooses to ignore the rules has everything to lose. When problems arise, these agencies won’t care what “handshake agreement” had been made with the employee, or how other businesses manage their employee relationships.

Protect yourself and your business by following employment rules carefully. Set an example of integrity with your employees from the very start. When your employees see that you are a “by the book” employer and business owner, they’ll be less inclined to ask you to bend the rules for them. They’ll come to trust that you have their best interests at heart.

Payroll and time tracking services can greatly simplify the job of processing and reporting payroll, but the employer still needs to understand the basic rules and do their part. When in doubt about payroll issues, seek professional guidance. Your attorney, an experienced accountant, or professional payroll service are all good sources of information.

The payroll page on our website contains information about popular payroll and time tracking services that integrate well with cloud accounting systems such as Xero. It also has links to websites of a number of government agencies related to employment issues.

 – Written by Gina Palacio, Owner of Level & True Accounting Services LLC