5 HR & Payroll Mistakes That Startups Make All Too Often

5 HR & Payroll Mistakes That Startups Make All Too Often

Posted February 13, 2019 by Alex Patriquin in Keeping Compliant
Startups are natural rule breakers. But HR and payroll mistakes are too common, and one area where companies don't want to break the rules.

5 HR Mistakes Startups Should Be Aware Of

Startups are natural rule breakers. You’ve got to ruffle a few feathers and disrupt the status quo if you want to build the next Facebook. But there’s one area where startups definitely don’t want to break the rules: payroll and HR.

Startups that don’t comply with payroll and HR laws can face serious legal and financial consequences. Some penalties are even severe enough to (almost) drive them out of business. With that in mind, we've put together this list of the five biggest startup payroll and HR mistakes to avoid.

1. Paying Employees with Personal Finances Instead of Company Funds

We've further discussed common financial mistakes startups can make here.

In the early days of a startup, having a business bank account can seem like a bit of a pointless activity. Brand new companies are rarely making any money and it might seem to the founder that there's no point in pretending like he's paying his employees with company (not his own) money. 

This is short-term thinking than can have dire consequences down the road. Eventually, that startup will have to disentangle all its expenses and pay back taxes.

If the startup is ever sued or audited, a blurry distinction of personal and business expenses can render a founder’s personal assets vulnerable to court seizure. A startup could even be stripped of its corporate status. Most founders think, “That will never happen to me.” But it often does.

2. Misclassifying Employees as Independent Contractors

Update: We've written a whitepaper you can download on how to correctly classify employees. 

Treating an employee as an independent contractor, when they should in fact be legally considered an employee, is one of the most costly mistakes a startup can make. Employers do it because they don’t have to pay taxes, insurance or overtime to independent contractors. They also don’t have to offer contractors benefits.

Misclassification is especially common in startups, where many practice “try before you buy” hiring. Yet if the responsibilities of the job don’t materially change when a contractor “converts” into an employee, the IRS considers that worker as having been an employee all along and can fine you for misclassifying them originally.

There are the state penalties, too. In California, the penalty for deliberate misclassification ranges from $5,000 to $15,000 for each violation.

What makes someone who works for you an employee? We wrote a blog post about this here. In short, it varies on a state-by-state basis, but the basic legal definition relates to how much “control” an employer has over when, where and how an employee works, and for how long. If the length of her engagement is indefinite, then she’s an employee.

Learn how to correctly classify seven different types of workers with our simple guide.

Get the Guide

3. Using a Payroll Service to Manage Payroll and Compliance

Payroll is so hard to do, and business screw it up so often, that the IRS penalizes about 1 in 3 business for payroll mistakes. The complexity of managing quarterly tax withholdings at the local, state and federal level.... it easily adds up to a full-time job, even for a business with just a couple of employees. That’s why most businesses use a payroll service.

But payroll services only get you so far. Startups still need compliance, like Worker’s Comp, EPLI and Unemployment Insurance. These are required in most states, including New York and California. Then there’s new hire reporting, I-9 documentation and healthcare. Compliance overhead in even the smallest of startups quickly escalates.

That’s why many savvy startups use a Professional Employer Organization (PEO) to manage payroll and compliance. A PEO manages payroll for startups, including myriad taxes, and ensures compliance with all required insurance and reporting. A PEO can even offer great deals on healthcare plans and other benefits.

4. Overpaying for Healthcare and Benefits

Startup competition is fierce these days. If you want to attract top tier talent, especially developers, you’ve got to offer excellent benefits, particularly with healthcare.

But even “good enough for now” healthcare plans are expensive, particularly for smaller companies, who pay more for less coverage. It’s the law of leverage at work: the larger the company’s employee base, the sweeter the deal.

What’s a startup to do? A PEO can again be helpful here. PEOs use a legal arrangement known as co-employment to bargain for and administer healthcare and benefits packages for all the companies under its umbrella, thus securing better terms than a startup could on its own.

PEOs can offer savings on medical, dental and vision plans, as well as 401(k), typically available only to much larger companies. PEOs even handle the burdensome paperwork of regulatory filings and plan administration.

5. Missing HR Services That Deal with Paperwork and Processes

Nobody likes paperwork, especially not fast-moving startups. Yet many businesses continue to use outmoded HR processes and legacy software. Stop the madness!

We're in the 21st century and there's no need to ask your employees to fill out forms and fax them to the government/healthcare company/other forces that be. There are several companies out there that are making software to help automate this and which help guide your employees step-by-step. When picking your HR system, prioritize something that works like your employees: online.

If you're a Justworks customer, you already know all of this. Justworks is a software based PEO that can help employers and employees better manage their paperwork and access top-notch healthcare.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, legal or tax advice. If you have any legal or tax questions regarding this content or related issues, then you should consult with your professional legal or tax advisor.