The cost of poorly managed, underperforming payroll can be high. Payroll errors can lead to either underpayments or overpayments, resulting in financial losses as well as dissatisfaction, decreased morale, or even legal action from employees.
Additionally, non-compliance with tax laws and labor regulations can result in significant fines and penalties. However, utilizing payroll best practices, businesses can streamline their payroll operations, reduce the likelihood of errors, and better navigate ever-changing regulations, thereby safeguarding their business and fostering a positive workplace environment.
Here are seven essential payroll best practices for successful and accurate payroll processing.
Payroll accuracy is critical, as even small errors can lead to significant employee dissatisfaction and legal consequences. While the American Payroll Association has found that nearly 60% of U.S. workers were confident in the accuracy of their payroll calculations, that still means at least two out of every five firms are struggling with pay accuracy. In particular, 32% of small business owners admit to payroll mistakes, but this may be understating the actual number.
The consequences of inaccuracy can be steep. Underpayment is the most common error, and a third (31%) of businesses that were fined for compliance failures said they had to terminate an employee to make up for the cost of the fines.
Plus, 37% of small businesses cite financial issues as a primary threat to their operations, so payroll mistakes—especially overpayments—can be particularly damaging. The solution: get a modern payroll solution that incorporates both automation and the expertise of experienced subject matter experts.
Compliance is a non-negotiable aspect of payroll. It’s also one of the most complicated because every business is subject to a constantly updating patchwork quilt of regulations coming from an alphabet soup of local, state, and federal government agencies.
In 2024 alone, for example, states including Colorado, New York, Maryland, and others, saw significant updates to laws affecting Family and Medical Leave, overtime, minimum wage, and more.
Payroll professionals must stay informed about these changes to avoid costly penalties. "There is no gray area, and administrators must stay on top of legislative changes to ensure compliance," Susan Tohyama, Chief HR Officer at HR software and services firm Ceridian, told the Society for Human Resource Management (SHRM).
Misclassification of employees, particularly regarding exemptions from overtime pay, is a common and costly mistake. For instance, improperly classifying workers as exempt from overtime can lead to substantial legal settlements, as seen with FIS Holdings Inc., which settled for $3.85 million due to unpaid overtime.
Complicating matters, this is an area of the law that’s often in flux. For example, at the beginning of this year, the U.S. Department of Labor issued new “regulations for determining whether a worker is classified as an employee or an independent contractor for purposes of the Fair Labor Standards Act (FLSA).” These changes rescind and replace previous guidance issued in 2021 and impact what kind of compensation different employees are owed under different circumstances—crucial information for payroll to get right or risk underpayments or overpayments.
These kinds of frequent changes are what make compliance such a burden for businesses, especially small to midsize employers that may not have dedicated compliance staff in-house. In such cases, partnering with a Professional Employer Organization (PEO) can be a valuable solution. A PEO offers expertise and advanced capabilities that can significantly assist business owners in managing payroll.
Digital tools and intelligent technology can streamline payroll processes, making them more efficient and reducing the likelihood of errors. Integrating payroll with other HR functions, such as time and attendance, can help manage large volumes of data and ensure timely, accurate payments.
Better yet, implementing a payroll solution that either is part of a larger HR platform or can integrate seamlessly with other HR and business systems can simplify and streamline the payroll function. "Combining payroll, employee recordkeeping, scheduling, and time and attendance into one system can help organizations manage large amounts of data during crunch time so they can meet goals and pay employees accurately and on time," says Tohyama.
Payroll is not just a transactional function; it’s a significant part of the employee experience. "For many people, their perceived worth is often tied to their pay," Sanja Licina, future of organizations leader at tech firm Globant, told SHRM. "So even when a small issue happens, it's often tied to a much deeper meaning within an employee, regarding their worth."
Tohyama agrees, arguing that payroll-related interactions present an opportunity to foster good employee relations. "When organizations approach payroll as solely a transactional experience, they are missing the opportunity to foster a strong connection and build trust with employees.”
As AI and automation increasingly take over repetitive tasks, payroll professionals are turning more toward strategic and value-generating rather than transactional activities. That’s a great development, but it also means ongoing training and professional development is needed to ensure payroll staff are equipped to manage complex issues, make informed decisions, and leverage new technologies effectively.
Don’t neglect soft skills, either. "Different professions, regardless of industry, [need] strong soft skills to be effective, and this applies to payroll professionals as well," says Licina. "The lack of these skills can cause unnecessary friction with employees and subsequently a large loss in productivity as more time is spent working to solve challenges that could have been dealt with more effectively."
For many small businesses, managing payroll in-house can be resource-intensive and prone to errors. Outsourcing the payroll function to a Professional Employer Organization (PEO) or similar HR provider can offer significant advantages, including better performance at a lower cost.
PEOs bring specialized expertise, access to advanced technologies, and economies of scale that small businesses might not achieve on their own. Additionally, outsourcing payroll frees up in-house staff, such as small business owners, to focus on revenue-generating activities. For more information, read our article, “What should you look for in a payroll service?”
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