Why Payroll Errors Are So Costly

According to IRS data, approximately 40% of small businesses incur payroll penalties each year. Beyond direct fines, payroll errors damage employee trust, invite audits, and consume disproportionate HR time to correct. The good news: most payroll mistakes are entirely preventable with the right systems in place.

Mistake #1: Misclassifying Employees as Independent Contractors

Employee misclassification is one of the most expensive payroll errors a business can make. When a worker who should be classified as an employee is treated as a contractor, the employer avoids payroll taxes — but opens the door to substantial back taxes, penalties, and interest if audited.

The IRS uses a multi-factor “common law” test to determine worker classification. When in doubt, classify as an employee. The cost of proper withholding is far less than the cost of a misclassification finding.

Mistake #2: Incorrect Overtime Calculations

The Fair Labor Standards Act (FLSA) requires overtime pay of 1.5x the regular rate for all hours worked beyond 40 in a workweek — but “regular rate” includes more than just base wages. It also includes shift differentials, non-discretionary bonuses, and certain other compensation.

Manual overtime tracking is prone to errors. Automated time and attendance systems calculate FLSA-compliant overtime in real time, flagging exceptions before they become payroll discrepancies.

Mistake #3: Failing to Track All Compensable Time

Under the FLSA, employers must pay for all time that is “suffered or permitted” — which can include pre-shift preparation time, travel between job sites, mandatory training, and even certain on-call situations. Many employers unknowingly underpay employees by failing to capture this time accurately.

Mistake #4: Missing New York State-Specific Rules

New York employers face additional payroll complexity including:

  • Spread-of-Hours Pay: An extra hour of pay at minimum wage when a workday spans more than 10 hours
  • Call-In Pay: Minimum pay requirements when employees are called in for a shift
  • Frequency of Pay: Strict rules about how often different employee classes must be paid
  • NYC Earned Safe and Sick Time: Accrual and usage tracking requirements

Mistake #5: Poor Record-Keeping

The FLSA requires employers to maintain payroll records for at least 3 years and time records for at least 2 years. Inadequate record-keeping doesn’t just create compliance risk — it makes it impossible to defend against wage and hour claims.

Modern time and attendance systems create immutable, timestamped audit trails automatically, giving you the documentation you need without any additional effort.

The Bottom Line

The common thread running through every payroll mistake on this list is data — specifically, incomplete or inaccurate time data. Investing in a reliable time and attendance system is the single most effective step most businesses can take to reduce payroll risk. Contact CTR/NY to learn how we’ve helped New York-area employers clean up their payroll processes for over 75 years.