© 2010 Ultimate Software Group, Inc.
All rights
Contents
Introduction ............................................. 1
Voiding and Reversing Payments .......... 1
Deductions and Earnings Taxation......... 1
Taxable Fringe Benefits .......................... 2
State Tax Issues—Reciprocals/
Employee Relocations ............................ 2
Year-End Preparation ............................. 3
Compliance Rules and Regulations ....... 3
Intercompany Transfers .......................... 3
Electronic Workflow and Approvals ........ 4
General Ledger Reporting ...................... 4
Retroactive Pay ...................................... 5
Conclusion .............................................. 5
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Too often, it’s easy to overlook the minutiae
of payroll processes, which can result in
costly errors and time-consuming
corrections. Even the smallest of payroll
slip-ups can snowball into long-term issues
and increased expenses, especially if those
mistakes continually occur. Seemingly
minor reconciliations—such as correcting
W-2s, amending tax returns, or adjusting
for late deposits—can waste time and
valuable resources. Additionally, some
blunders make organizations vulnerable to
regulatory fines and penalties.
The good news: most common mistakes
are avoidable. Auditing, testing, reporting,
and other “checks and balances” can
confirm that your payroll is accurate the first
time. But when mistakes happen, it’s
important to determine what occurred and
why, and then identify the root causes so
they don’t happen again.
Following are some of the top 10 payroll
pitfalls, along with practical ways to prevent
them.
1. Voiding and Reversing Payments
Voiding and reversing payments pose
specific challenges, especially if those
measures aren’t taken quickly and
accurately. What if payroll receives a
returned check or an Automated Clearing
House (ACH) reversal and places it in a file
for future processing—only to completely
forget about it? Or what if an employee
terminates and there’s a batch of checks
left behind, unprocessed? These issues
pose huge risks. Returned checks or ACH
transactions should be processed
immediately. For instance, voiding a check
in a subsequent quarter can result in
negative wages in that quarter if the
employee is no longer with the company.
Voids may or may not flow through the
general ledger (GL). Test your system to
ensure that voids reverse the exact, original
transaction in the GL.
Keep in mind, a void is not just a check that
comes back. It could be a returned ACH
payment and you might have to reissue or
refund money when processing an ACH
reversal. It’s smart to ensure there’s a
process in place to reissue funds to the
employee in a way that does not impact W-2
wages.
Reversals or other negative adjustments can
also present a challenge. Design a clear way
to process them correctly. Confirm that wages
and taxes are updated—don’t just assume.
Find out if these transactions should post to
the GL. (Sometimes, reversals and negative
adjustments are done through a tool bench in
the software and don’t flow all the way
backward to the GL.)
Costly errors with voids and reversals are
avoidable simply by processing them
promptly. Don’t hold them until the end of a
quarter or year—process the void the same
day you do the reissue (if there is one). Set up
a log to track voids, and once you put them in
the log, make sure you go back and verify the
adjustments are made to the employee’s
record. A simple report can confirm the
transaction was posted. Never assume it was.
As a rule, schedule a supplemental payroll for
quarter-end and year-end. Count on having to
make these adjustments and try to capture as
many corrections as possible in that
supplemental payroll. Make sure those
reconciliations are posted and you have the
desired outcome. These steps can help
ensure that voids, reversals, and adjustments
do not result in negative wages.
2. Deductions and Earnings Taxation
When it comes to deductions and earnings
taxation, there’s one thing we can count on:
nothing stays the same. As companies offer
new perks, benefits, and incentives, the
payroll challenge is to ensure these
deductions or earnings are properly configured
with accurate calculations and reporting. Don’t
confuse pre-tax and after-tax deductions. That
distinction, if unheeded, can lead to
employees or employers paying unnecessary
taxes. Taxes can get over-deposited, the GL
isn’t correct, and eventually that means
amended returns, W-2c’s, or changes to the
GL after a period-close. The time spent
researching and fixing employee wages and
filing tax returns and W-2c’s can quickly add
up.
If the error goes the other way (taxes were not
withheld—but should have been), you might
1
be in the uncomfortable position of
experiencing surprise tax bills or major
withholding adjustments—which can result
in serious morale issues with employees.
And once employee trust is broken, it can
be hard to reestablish.
The best defense: proactive planning. Do
the necessary research in advance. If your
company adds an earning, deduction, or
perk, find out what the associated taxation
should be. Look for federal income tax,
state income tax, local income tax, Social
Security, and Medicare handling.
Determine if these earnings or deductions
are reportable on form W-2. If so—in what
box? If it’s in Box 12, what code? Review
Publication 15 or Publication 15B on the
IRS.gov Web site for important information
on the taxability of earnings and
deductions.
The American Payroll Association’s (APA)
Web site is another valuable source for this
information. It’s also a good idea to consult
your payroll vendor to determine how
deductions and earnings taxation should be
properly set up in your system. And once
again, test, test, test to ensure accuracy.
3. Taxable Fringe Benefits
Taxable fringe benefits are similar to
earnings and deductions but require some
additional special handling. Taxable fringe
benefits involve taxation on non-cash
earnings—such as a non-cash benefit or
award (e.g., a group-term life-insurance
policy). Fringe benefits are typically taxable
for all types of taxes. However, keep the
difference clear between taxable and
withholding. These benefits are imputed
earnings, which means an amount must be
added to the taxable wage only to calculate
taxes. It increases wages for W-2 reporting,
but not the cash.
With a group-term life insurance policy, the
earnings increase the taxable wages,
requiring organizations to calculate
whatever taxes must be withheld. The
deduction then reduces the employee’s net
pay so he or she doesn’t receive cash.
Make sure that Social Security and
Medicare assessments are withheld from
taxable fringe benefits so the employer
portion will also be calculated and paid or
deposited.
IRS Publication 15B applies specifically to
taxable fringe benefits. To confirm reporting
procedures on the W-2, review the W-2
instructions (also on the IRS site). In
particular, pay close attention to the
instructions for Box 12. This provides a guide
for how the information should be reported.
The APA is another resource for additional
information.
Another tip: process fringe benefits when they
occur. Don’t wait until the end of the year. If
there’s a lengthy delay and the employee
terminates, the company is subsequently
responsible for the taxes. Many companies
process group-term life insurance benefits in
December for all employees. But employees
terminate throughout the year, which could
leave the company responsible for the taxes if
these fringe benefits aren’t processed in a
timely manner.
When an organization pays taxes on behalf of
its employees, there’s an obligation to “gross
up” their wages and account for the taxes paid
on their behalf. This creates an inefficient
condition in which the company may be
continually making updates. The best practice
is to process taxable fringe benefits as they
occur (even monthly or quarterly) to stay
timely and prevent increased costs.
4. State Tax Issues—Reciprocals/Employee
Relocations
State tax issues—specifically as they relate to
employees who move during the year or
reciprocal agreements—can be difficult to
interpret and can cause long-term
consequences if handled incorrectly.
The first challenge is to understand the true
nature of any reciprocal agreement that exists.
Reciprocal tax agreements eliminate the need
to pay income taxes in multiple states and
apply when an employee lives in one state but
works in another. Some states have reciprocal
agreements, while others do not. Find out if
your employees are covered by these
agreements. Sometimes taxes are withheld in
the “work state,” and other times they’re
withheld in the state of residence. There are
even circumstances where wages are
2
reported and taxes withheld in both states.
Another challenge arises when an
employee moves but forgets to notify the
HR department. This can be an especially
difficult challenge if the employee notifies
HR after W-2s are issued—which
unfortunately is not uncommon.
If there are employees living in one state
and working in another, determine if
reciprocal agreements exist and how taxes
are handled. The APA’s Guide to State
Payrolls is an excellent starting point. You
can also consult individual state Web sites.
It’s a good idea to check both states to be
sure the information is consistent. If a
reciprocal agreement applies, understand
how to set it up in your payroll system and
test it to make sure you’re getting the
desired outcome. Run reports to ensure
that wages are only reported in one state
and that they appear in the correct state
income tax boxes.
5. Year-End Preparation
The fiscal year-end is one of payroll’s major
challenges—and almost every payroll
professional has at least one horror story
from a year-end gone awry. But with good
organization and planning, year-end
processing can be a smooth and
successful process. The fact is, a trouble-
free year-end starts in the first month of the
fiscal year.
Create a year-end team comprised of
smart, efficient people from multiple
departments—accounting, IT, tax
accounting, and, of course, HR and payroll.
Have a checklist that starts with the existing
needs—such as changing your calendar or
extending it for next year, meeting year-end
filing deadlines, or adding a supplemental
payroll. Look back to your previous year
and see what went well and what didn’t,
and add those items to your checklist.
Start by balancing your payroll and taxable
wages, and look for errors early. Run
reports to spot negative wages now so that
those problems can be fixed right away,
rather than facing the stress of trying to
remediate everything in the waning days of
the fiscal year.
Many payroll professionals also recommend
attending the APA’s annual conference or a
vendor’s year-end seminar to stay compliant
and up-to-date on changes. There, you’ll get
checklists, tips, and tricks of the trade, as well
as an opportunity to network with colleagues.
6. Compliance Rules and Regulations
Compliance remains a critical topic for HR
professionals and failing to keep up with
changing rules and regulations can cause
serious consequences—in the form of fines
and penalties for late tax filings, improperly
calculated overtime, and incorrect payments.
But there are also positive incentives to
staying abreast of compliance law, such as the
benefits to companies from COBRA subsidies
and the New Hire Act.
Stay in the know. Start with vendor
notifications. Vendors often email news alerts
about pending or enacted legislation and how
their solution will deal with the issue. Other
vendors use blogs to post updated
information. User group meetings and industry
trade associations can also be good resources
for staying atop these issues.
Stay tuned to the general and trade media.
Many of the changes in the HR industry often
gain at least a small spot on the news, which
can spur you to find out more details by
visiting the Web sites of organizations like the
IRS, Social Security Administration, or
Department of Labor.
7. Intercompany Transfers
Many companies have more than one Federal
Employer Identification Number (FEIN) today,
and it’s not uncommon for these organizations
to transfer employees from one FEIN to
another. There are also often regular
corporate acquisitions and divestures, all of
which create some challenges. Find out what
the tax implications of these intercompany
transfers are (if any). If the employee transfers
are due to an acquisition, determine if a
successorship exists, and if so, whether taxes
will be treated differently. Social Security,
State Unemployment Insurance (SUI), and
Federal Unemployment Tax Act (FUTA)
typically “reset” and start over, requiring the
employee to file for a refund on excess
Federal Insurance Contributions Act (FICA)
3
payments. (Unfortunately, the employer
does not receive the same benefit and
must pay twice.)
Make sure all other year-to-date figures
total correctly—not just taxes. Reconcile
accounts such as 401k plans, 401k loans,
and flexible spending accounts (FSAs).
Another challenge may be the tax reporting
itself. Deduction records might transfer but
make sure they’re updated and calculating
as expected. This helps prevent correcting
W-2s, amending tax returns, and paying
penalties for incorrect wage reporting.
8. Electronic Workflow and Approvals
Employee and manager self-service have
rapidly become a requirement for HR and
payroll systems as companies strive to
reduce their eco-footprints and
administrative workloads. Electronic
workflows and approvals are the heart of
these initiatives. Although conceptually
straightforward, the execution can be a
management challenge for many
organizations. For instance, one risk is
configuring too many or too few approvals.
There’s also a potential for transactions to
pass through without necessary reviews.
That’s often an outgrowth of too many
approvals, in which a reviewer only gives a
cursory look at the transaction or data.
The potential benefits and savings are self-
evident: increased efficiency, faster
processes, lower risk, and less paperwork.
Electronic workflows reduce or even
eliminate paper forms and filing. But
success with workflows requires thoughtful
design. Carefully analyze which
transactions truly require approval and how
many levels of approval are required. For
instance, a company might allow
employees to add or change their direct-
deposit data. Does that really need
administrative approval? Perhaps not, in
many cases. Or you might review a paper-
based payroll process that has traditionally
required three signatures and conclude that
only two approvals are needed in an all-
electronic environment. Create the
workflows that make the most sense for
your organization.
It’s a similar story with notifications. They may
seem like a great idea—until you start
receiving dozens or even hundreds each
week. Notifying a payroll clerk of every change
that comes through could create an
unwelcome tidal wave of notifications clogging
the email inbox.
9. General Ledger Reporting
GL reporting might not seem like an HR or
payroll function. Yet, if payroll is processed
incorrectly, it can lead to major GL issues. For
instance, if rules or mappings are configured
wrongly, wages, deductions, or taxes could
end up in the wrong cost center, the wrong
department, or even the wrong account,
wreaking havoc with labor reporting.
It’s easy to overlook new earnings,
deductions, and taxes when configuring the
GL, so some records end up not being posted.
A re-organization can also cause major issues
with GL mapping from payroll. It’s a good idea
to remember that items not posted typically
end up in some kind of a suspense account.
The pitfalls here can cost you hours or days of
time researching the root causes of why
something did or did not post to GL, or why it
posted incorrectly.
Unfortunately, GL mapping is typically one of
the last areas where payroll teams look for
errors. The time spent fixing incorrect entries
can represent a major hidden cost in the form
of either adjustments that must be made to the
payroll that then flow through to the GL, or in
manual journal entries. Plus there is the time
spent by the manager who must explain why
labor costs are off.
Best practice recommendations include
reviewing your GL output to ensure there are
no gaps. Create a checklist when you’re
adding codes for new earnings, entities, and
taxes. Make sure that there’s a step to
configure GL mapping. If it’s a major change,
perhaps a restructuring or reorganization,
consider creating an entire test environment
so you can “pilot” these changes without
impacting the production environment.
Balance your payroll registers to the GL.
Payroll can do this before or after sending a
file to finance. But remember—payroll
registers are your source document, so you
4
should always try to tie your GL back to
your source document. Then run reports to
ensure everything maps correctly.
10. Retroactive Pay
Retroactive pay can be especially
challenging and time-consuming. “Retros”
can arise from late salary increases,
missing hours or punches from the
company’s time system, incorrect
commissions, or other pay calculated by
someone else. It’s essential to fully
understand what the retro pay is for and to
what periods it applies to determine exactly
where to include it.
With retroactive pay, there are risks and
costs for both underpayment and
overpayment. Underpayments lead to
morale issues, as the employee questions
why they didn’t get all of the money they
thought was deserved. Overpayments
create claw-backs and one-time
withholdings that are equally problematic.
To avoid retro problems, develop a policy
and follow it. For instance, payroll staff
might mandate that salary increases only
happen on the first day of a pay period.
You might end the issuance of manual
checks so retro pay must be included on
the following regular paycheck.
Have a clear picture of when the increase
was effective or what was impacted. Track
hours or days carefully, so you know what’s
impacted by an increase. Make sure you
account for overtime or any percentage-
based differential or premium and then
ensure you include all applicable earnings.
Conclusion
Most payroll errors, such as the top 10
addressed above, are preventable. To find
out more about best practices in payroll
processing and avoiding the pitfalls, visit
the Ultimate Software Web site at
www.ultimatesoftware.com.
You can also find valuable resources at
www.americanpayroll.org. Click on the U.S.
map and choose a state to see every
relevant Web site for that state—including
sites for issues such as child support, labor,
taxation, unemployment, and more. Additional
useful resources include Web sites for the
U.S. Department of Labor, the U.S. IRS, and
the Social Security Administration.
However, the best way to avoid costly payroll
blunders is to use a payroll solution that you
control, and one that delivers all federal, state,
and local tax updates automatically every
quarter. For optimal results, the solution
should be unified with time and attendance,
core HR, benefits, and talent management. A
truly unified solution ensures that any changes
made in one area of human capital
management will automatically create an
update for payroll processing. Plus, an all-
inclusive solution gives you across-the-board
business intelligence and instant reporting for
quick analysis and decision-making.
Ultimate Software is the leading provider of
unified, end-to-end human capital management
(HCM) Software-as-a-Service (SaaS) solutions in
North America. Ultimate’s award-winning
UltiPro® delivers comprehensive HR, payroll, and
talent management for organizations of all sizes to
manage the global workforce from recruitment
through retirement. With SaaS, UltiPro’s all-
inclusive HCM provides unparalleled functionality
accessed 24-7 through a secure Web portal—
resulting in maximum convenience, efficiency, and
savings.
To learn more, call: 1-800-432-1729 or send an
email to ultiproinfo@ultimatesoftware.com.