Managing payroll is one of the most crucial tasks for business owners, and unfortunately, it is an area where things often go wrong. A common mistake is writing payroll checks directly from a general operating account. This approach might seem harmless, but it can create significant problems, especially when managing the taxes withheld from employees. Here's how this happens and how you can fix it.

Payroll fund allotment

When you process payroll, you're not just paying your employees—you're also responsible for funds. These are the taxes withheld from employees' paychecks for federal income tax, Social Security, and state agencies. The problem? This money isn't yours or your employees' to spend. Many business owners leave these funds in their regular checking accounts. After paying employees, they see a healthy bank balance and start spending, unaware that a portion of that money is already spoken for. When the IRS or state agencies come calling for their cut, the funds are gone, leaving the business owner scrambling.

Separate payroll account

The solution to this common problem is simple: create a separate payroll account. This will clearly separate your money from the money that belongs to the IRS, Social Security Administration, and state agencies.

Here's how it works. First, calculate your payroll. Imagine your gross payroll is $10,000, and your employees' net pay is $8,000. Transfer the $8,000 net pay into the payroll account and the $2,000 withheld for taxes. Include your share of payroll taxes, typically around 10% of the gross payroll. In this example, you'd transfer $11,000 into the payroll account.

Once the funds are in the payroll account, use it exclusively for payroll purposes. Pay your employees from this account and authorize the IRS, Social Security Administration, and state agencies to withdraw directly from this account. This process ensures that taxes are paid on time and eliminates the temptation to spend fiduciary funds on other expenses. Using a separate account reduces the risk of fraud or unauthorized withdrawals since the account only contains the exact amounts needed for payroll.

The added benefits

This system offers several advantages:

• Improves cash flow management - It gives you a more accurate view of your operating account—no more false confidence from seeing fiduciary funds in your general balance.

• Simplifies compliance - Tax agencies take a hard stance on mishandling fiduciary funds, and a dedicated payroll account ensures you're always ready to pay on time.

• Provides peace of mind - Knowing that payroll funds are safely set aside reduces stress and eliminates surprises.

Plan ahead

Creating a separate payroll account is a small but impactful change that can solve payroll cash flow issues and protect your business from unnecessary risks. The next time you're preparing payroll, take this step. It's an investment in better financial management, fewer headaches, and a smoother operation overall.