7 Common Restaurant Payroll Mistakes

7 Common Restaurant Payroll Mistakes
Kelsea Schnitzler

By Kelsea Schnitzler

Restaurants are similar to spider webs.

They all appear similar, but when you look closer each web is intricately woven in unique patterns. This is just like a restaurant, made up of its own interconnected components. Every department and all the operations around those departments need to work together seamlessly to ensure the smooth running of the business. It's a delicate balance that's easy to disrupt.

What's one of the most common ways to disrupt this delicate ecosystem? Payroll. Payroll is a web of its own.

Consequences of payroll mistakes

Small payroll mistakes can lead to costly consequences like compliance issues, financial penalties, higher employee turnover, and even lawsuits. When you complete payroll manually, mistakes are inevitable. Take this story from Leo Smigel, the founder of Analyzing Alpha who's been involved with several restaurant ventures:

"My buddy really got himself into a pickle. He had this cool little bistro that was doing pretty well. You know how it is with small businesses. He had to juggle a ton of stuff himself, including doing payroll by hand. But, let's be honest, keeping track of all the numbers wasn't his cup of tea, and he messed up a few times.

Then, out of the blue, these labor audit folks showed up, and man, did they find a heap of issues. They discovered he'd gotten overtime wrong, goofed up the tip records, and even made a few mistakes with the tax stuff. Because of all these mix-ups, he got slapped with some big fines. And the audit was a pain in the neck—he had to dig out all sorts of paperwork and answer a million questions, which ate into the time he should have been spending running his place.

But the thing that really stung was how his staff reacted. Some felt they'd been shortchanged because of the payroll snafus. It took him a good while and a lot of elbow grease to win back their trust.

What happened to my friend was a real eye-opener for a lot of us in the biz. It drove home how important it is to keep your records straight, why you should use a decent payroll system, and how you've got to stay on top of the rules and regs. We all learned a lesson from his tough experience." -Leo Smigel

To avoid these risks, many restaurants are turning to payroll providers like 7shifts Payroll software that are specifically designed for the unique needs of the hospitality industry. They can help you avoid the two most common categories of payroll mistakes, which fall under labor and tax compliance.

Most common labor payroll mistakes

2 women looking at a laptop behind the counter of a restaurant

1. Misclassifying employees

To set your payroll up for success from the beginning, you need to determine if a worker is an employee or an independent contractor. Employees are typically subject to more oversight and are entitled to benefits like minimum wage, overtime pay, and workers' compensation insurance. On the other hand, independent contractors have more freedom and control over their work but are responsible for their own taxes and insurance.

Once your workers have been classified as employees, you'll need to determine their job duties and pay rate to ensure they are properly classified as exempt or non-exempt under federal and state labor laws. This includes determining whether they are eligible for overtime pay and ensuring that they are paid at least the minimum wage.

Employees and independent contractors are required to fill out income tax forms for employers, which are the W-4 and W-9 respectively. 7shifts' Employee Onboarding streamlines this process with the ability to send custom onboarding packages. New hires will receive the correct government forms to sign and information is safely stored in their profile for payroll.

2. Mishandling of pooled tips

Different jurisdictions have specific guidelines about how tips can be shared amongst your team. For example Labor Code Section 351 in California says, “every gratuity is hereby declared to be the sole property of the employee or employees to whom it was paid, given, or left for". This has been interpreted to allow for:

  • Involuntary tip pooling as long as the tip pooling policy is not used to pay owners, managers, or supervisors

  • Employers to require employees to share tips with other staff that provide service in the restaurant

This is just one example from one state about how pooled tips should be handled for payroll.

3. Not complying with minimum wage and overtime laws

While the Fair Labor Standards Act (FLSA) states a national standard for minimum wage and overtime pay, states are allowed to set their own labor laws, which may have different overtime rules for restaurant employees. Some states have more strict overtime rules than the federal standard, like in California and New York. Other states have exemptions for certain types of restaurant employees, like tipped employees who may be paid a lower minimum wage in exchange for tips. It's imperative that restaurant operators are fluent in their local laws, or get help from software. 7shifts has built-in compliance features including advanced location-specific settings to help set up your payroll for success.

Most common tax payroll mistakes

Woman looking at a laptop at a restaurant

1. Failing to correctly withhold employee taxes

The two potentials here are overpaying, which ruins your bottom line. Or, underpaying which could lead to penalties and fines. To correctly withhold your employees' taxes, restaurant operators need to obtain a completed Form W-4 from each employee. This form includes the employee's filing status, number of dependents, and any additional withholdings. You can then use this information to calculate the amount of federal income tax to withhold from each employee's paycheck. Employers must also withhold Social Security and Medicare taxes from employee paychecks, and in some states, state income taxes too. Tax laws and regulations can vary by state, so it's important to not overlook local labor laws.

2. Forgetting to include all taxable compensation

What's included in taxable compensation? Any forms of payment subject to federal and state income tax. On top of wages and salary, examples include:

  • Tips, bonuses, commissions, service charges

  • Non-cash tips like gifts cards

  • Fringe benefits like health insurance, meal allowances, parking benefits, employee discounts

  • Overtime pay

  • Vacation pay

  • Sick pay

All taxable compensation should be included in an employee's gross pay and all necessary taxes should be withheld. This can be a lot to keep track of, and why a trusted professional is often tasked with running payroll.

3. Failing to keep accurate records

Does it really matter if your records are off a bit? The short answer is yes. There's multiple reasons why keeping accurate payroll records sets your business up for success:

  • When the IRS comes knocking, you want to be ready to answer. Accurate payroll records prove compliance with federal and state labor laws, and it makes your payroll process simpler. Payroll software helps keep your records organized, and easy to pull up when you need access.

  • If any employee disputes their earnings, an accurate paper trail provides a clear record. This can be used to resolve issues and maintain transparency with your staff.

  • No matter how hard you try, mistakes are bound to happen. Accurate record-keeping can help to identify errors or inconsistencies in the payroll process, allowing them to be corrected before they lead to costly penalties or legal issues.

  • Finally, accurate records can also help restaurant owners and managers to analyze labor costs, identify trends, and make informed decisions about staffing and scheduling.

If you currently use a payroll software and you're finding inconsistencies in your records, it may be time to move on. Check these signs you should switch payroll companies for more.

4. Failing to meet tax deadlines

Depending on the authority and infractions involved, failing to meet your tax deadlines can result in financial penalties, interest charges, and even legal issues. An easy way to meet federal and state tax deadlines for filing payroll taxes is to set up a repeating reminder in your calendar. Filing your restaurant's taxes isn't something you speed through. You'll need ample time to ensure payroll data is accurate and up to date, and that the taxes are calculated and withheld correctly. It's important to note that some states have additional tax requirements and deadlines beyond federal requirements, so restaurant owners and managers should stay informed about all applicable tax laws.

Setting yourself up for success

Feeling nervous about running your first payroll? We're here to arm you with the resources and products you need to succeed.

Read our Ultimate Restaurant Payroll Guide.

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Kelsea Schnitzler
Kelsea Schnitzler

Before I began writing for a living, I worked in restaurants for almost a decade. Now in the marketing world, I apply my experiences to create helpful content for the 7shifts community.