Steps of conducting an Internal Payroll Audit?

As an employer, you are required to comply with wage and hour and employment tax laws that occur on a federal, state and local level. Conducting periodic audits at least once or twice per year helps you maintain compliance and strengthen your company’s financial controls. The audit enables you to verify that payroll records are correct and to spot and fix issues that could have led to an external audit. A qualified member of your staff or a third-party auditor can perform the audit.

Step 1

Verify duties of all workers in the payroll department and ensure their payroll system access is restricted to the type of work they do. For example, if an employee’s job description is timekeeping and payroll record changes, she should not have the system access required to process paychecks.

Step 2

Generate a payroll report that identifies active employees, and confirm that these employees actually work for the company. Run a report to identify terminated employees, and ensure that they are not getting paid. This helps you recognize ghost or phantom employees, which is a type of payroll fraud. The ghost employee may be a terminated employee who has not been taken out of the payroll system or a fictitious employee who does not work for the company.

Step 3

Compare regular and overtime wages with employees’ timekeeping data, which should be approved by their respective supervisors or managers. Verify salaries, pay increases and supplemental wage payments such as commissions and bonuses.

Step 4

Confirm that mandatory deductions, such as and payroll taxes and wage garnishments, if applicable, are being withheld from employees’ wages. Generate a report that shows the company’s employment tax liabilities, and verify that your employees’ withholding and your portion of taxes are paid and reported to the appropriate government agencies.

Step 5

Evaluate employee benefits, such as health insurance and retirement benefits, and balance payments made to vendors. Review fringe benefits, including expense reimbursements and vacation and leave procedures.

Step 6

Reconcile amounts paid to employees via live checks and direct deposit and amounts paid to third parties with the amounts posted in your company’s financial statements. Ensure accurate coding.

Step 7

Confirm that all wage and hours laws that pertain to your business are being met. This includes Fair Labor Standards Act policies for classifying and paying nonexempt and exempt employees and related state and local policies.

Step 8

Assess record-keeping procedures to ensure compliance with federal and state record-keeping laws. Verify that payroll records are stored in secured areas.

Step 9

Review internal payroll policies, such as confidentiality clauses and policies relating to termination, timekeeping, paycheck distribution and security breaches.

Step 10

Create a written evaluation of your findings and your suggestions for improving internal controls.

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5 Payroll Tax Mistakes to Avoid

5 Payroll Tax Mistakes to Avoid

 

If you have at least one employee, you’re responsible for payroll taxes. These include withholding federal (and, where appropriate, state) income taxes and FICA tax from employees’ wages as well as paying the employer share of FICA tax and federal and state unemployment taxes. The responsibility is great and the penalties for missteps make it essential that you do things right.

1.   Misclassifying workers

 Perhaps the hottest audit issue today is misclassifying workers. There’s incentive to treat workers as independent contractors rather than employees because payroll taxes and employee benefit costs are high; a company’s only tax responsibility for an independent is issuing a Form 1099-MISC if payments in the year are $600 or more.

You don’t have the freedom to select the label for the worker; classification depends on whether you have sufficient control over the worker. This essentially means having the right to say when, where, and how the work gets done. Having an independent contractor agreement is helpful in showing that you and the worker do not intend any employer-employee relationships, but it doesn’t bind the IRS, who is not a party to the agreement.

Find information about worker classification  from IRS. When in doubt, consult your tax advisor.

2.    Not using an accountable plan for employee reimbursements

If you normally pay for travel, entertainment, tools or other business costs for employees, you’re wasting employment tax dollars if you don’t use an accountable plan. With this arrangement, you deduct the expenses but avoid all payroll taxes on reimbursements; employees do not have any income from reimbursements.

To be an accountable plan, the employer must formalize the arrangement and set reasonable times for action (the following times are reasonable to the IRS but you can adopt shorter time limits for action):

• The reimbursable expense must be business related.
• Advances cannot be made before 30 days of the expense.
• Employees must account for the expenses within 60 days of the expense.
• Employees must return excess reimbursements to the employer within 120 days of the expense.

Find details on accountable plans from the IRS.

3.    Failing to keep payroll records

You are required to maintain payroll records and have them available for IRS inspection. These include time sheets, expense accounts, copies of W-2s and other payroll records. Usually, you should keep information for at least four years.

4.    Choosing to pay creditors before the IRS

When a business gets into a cash crush, it may be tempting to pay the landlord, vendor, or utility company before the IRS; don’t! As a business owner, you are a “responsible person” who remains 100% personally liable for “trust fund” taxes (amounts withheld from employees’ wages). This is so even if your business is incorporated or is a limited liability company.

Best strategy: Set aside cash to cover payroll taxes so you won’t use these funds for any other purpose. Find more information about the trust fund recovery penalty from the IRS. 

5.   Failing to monitor payroll company activities

Many small businesses use outside payroll companies to handle the job of figuring withholding as well as transferring funds to the U.S. Treasury to cover payroll taxes. However, some of these companies may not do their job, by error or intentionally. As an employer, even if you use an outside payroll company you remain responsible for payroll taxes.

Best protection: Monitor your tax account to see that funds are being deposited on time and in the correct amount..


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