5 Payroll Red Flags

The following are payroll "red flags", which are signals to various regulatory agencies that you're probably doing something wrong in your payroll processing and could trigger them to complete an audit or if found during an audit may require them to take a longer look into your records.

Agencies talk to each other if they find something during an audit, you are much more likely of getting audited by another agency.

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1. Too Many Exempt Employees
The rule of thumb is that no more than 1/3 of your employees should be exempt from overtime. This will fluctuate, of course, based on your business; a professional services organization will have a much higher number of exempt employees, while a manufacturer or a construction company will have a much lower number. If your percentage is higher than 1/3, you should at least investigate.

2. Poor Record Keeping or unbalanced W-2 and 941
If you can't explain problems or have trouble digging up requested files, the auditor is not going to give much credence to your records. This may result in a more careful, and lengthy, review with more follow-up visits. In addition, if your records don't balance, don't expect the auditor to just assume everything is OK.

3. W-2's and 1099's
Avoid issuing W-2's and 1099's in the same year for the same person. Doing so signals that you are treating an employee as a contractor at the same time, which is probably incorrect. It might also occur because you are giving them a fringe benefit for which you think a 1099 is appropriate when it is not.

4. 1099's and Accounts Payable checks to Social Security Numbers and/or individual name.
Issuing 1099's to individual names and social security numbers begs the question, if you really have a contractor, why don't they have a DBA and a FEIN? They might legitimately be contractors, but they will attract the attention of an auditor.

5. Contractor Gets in Trouble with the IRS
If one of your contractors can't pay their taxes, they may attempt to shift the blame back to you for not having withheld taxes like "you should have." Be prepared to defend your decision to make them a contractor.