Today I’m answering the question, should your startup backdate payroll?
And my emphatic answer is NO. Please do not do this. Do not backdate any payrolls for any reason.
The reason you do not want to backdate payroll is because you’ll create compliance problems with the IRS. I know - it seems so simple just to run those payrolls on a historical date and everyone gets paid and you’re catching up with money you owed employees…
But, the IRS takes payroll taxes very seriously. That’s one of the main tax revenue drivers in the United States.
And so if you start backdating payroll, you’re going to run into a problem because all the payroll providers file payroll tax quarterly reports with the federal government and the States. Payroll providers share a Form 941 with the IRS every quarter. Any time you are going into your payroll system and backdating pay after that 941 is filed with the federal government, you are sending contradictory information to your payroll provider and to the IRS. The payroll provider is going to report this to the IRS - the payroll provider is not going to get into trouble with the IRS on your behalf because you want to run payroll historically.
Do not do it. Please, it’s going to create a ton of problems. People don’t know, but payroll penalties, payroll tax penalties create a lot of problems for companies and it’s a lot of paperwork. It’s a lot of time spent on hold with the IRS or trying to catch up or paying a specialist to handle those payroll tax re-filings.
Can founders backdate their own pay after they raise funding?
NO, you should not do this. The use case we see companies trying to do backdating is when startup founders do not want to take salary until they raise funding, which makes sense. Before the startup has raised funding, there is no money in the bank, so they don’t draw any salary. And so what the founders do, the logic is they think, “Well, hey, I’ve been spending three to six months raising money. So I raised money and now I’m going to pay myself for those three to six months in the past.”
And again, I totally get the logic and it makes perfect sense, but again, backdating the payroll is going to cause problems with the IRS.
The right way to catch up founders’ salaries after the startup raises capital
What I would recommend is if you start working in a startup prior to raising capital, and you are planning on not drawing a salary until after you raise funding, is that you should put into your contract that you’re going to get a bonus when you raise the capital. So instead of running a back payroll, you’re actually going to be in compliance with the IRS because you’re collecting that bonus payment that’s in your contract.
It’s very important to have this in your contract or as an agreement with the board so that it’s documented ahead of time so that you can show the IRS that you weren’t just playing around and ran a bonus payroll for six months of retroactive payroll. You want to have this all documented properly. But if that’s in your contract you have the agreement with the board, you do raise the cash, then it’s perfectly fine to run a bonus payment for the successful raising of capital. And now you’re going to be running your normal payroll. And if you are a founding team who wants to get paid for the time spent on the company prior to the fundraise, circulate a document with each founder that states how much you’ll be paid in a bonus after you raise funding.
The big takeaway needs to be just please don’t run retroactive payrolls. It’s going to get you in compliance problems. You’re going to spend less time building your startup and more time dealing with the IRS or you’re going to have to pay someone like Kruze to fix this stuff. If you are wondering what the average startup CEO salary is, check out our Startup CEO Salary Report, where we breakdown the typical CEO pay based on startup round, industry and funding raised.
How Far Back Can You Backdate Payroll?
The answer is simple: you shouldn’t backdate payroll. Backdating payroll can create compliance issues with tax authorities like the IRS. Payroll providers file quarterly reports, and contradictory information due to backdated payroll can lead to penalties and additional paperwork.
Compliance Issues
When you backdate payroll, it conflicts with the quarterly payroll tax reports that payroll providers submit to the IRS. These reports, including Form 941, are critical for tax compliance. Any attempt to alter payroll dates after these forms have been filed will result in discrepancies that the IRS will notice.
- Payroll Process: The payroll process is designed to ensure timely and accurate tax filings. Disrupting this process by backdating can cause significant issues.
- Payroll Software: Most payroll software systems are set up to prevent backdating due to these compliance risks.
- Check Date: The check date is another critical element. Changing this date after a report has been filed is a red flag for auditors.
Penalties and Additional Paperwork
The IRS takes payroll taxes seriously, as they are a major source of federal revenue. Backdating payroll can lead to:
- Penalties: These can be severe and can accumulate quickly.
- Additional Paperwork: Correcting backdated payroll requires amending previously filed tax forms, which is both time-consuming and costly.
Specific Circumstances to Consider
Some might consider backdating payroll for various reasons, such as trying to cover missed payments or aligning payroll with specific business cycles. However, the risks outweigh the benefits.
- Retro Pay: Instead of backdating payroll, consider issuing retro pay to cover missed payments legally.
- Direct Deposit: Ensure all direct deposits are made timely to avoid complications.
- Employee Wages and Salary: Adjust wages and salaries within the correct pay periods to maintain compliance.
Legal Alternatives
If you need to compensate employees for past work, consider these alternatives:
- Bonus Payroll: Document and provide bonus payments for work done before raising funds, ensuring it’s clearly stated in employment contracts.
- Back Pay: Issue back pay for any owed wages, but ensure it is processed correctly in the current payroll period.
- Paper Check: Use paper checks for any corrections needed outside of normal payroll cycles to avoid altering previous reports.
If you are really going to do this, talk to your payroll provider and an employment or corporate attorney and find out how far back you can backdate it and get a list of the dangers so you know what you are getting into.
Conclusion
Backdating payroll is not advisable due to the significant compliance issues it creates. Always ensure payroll is processed accurately and timely to avoid penalties and additional paperwork.
By adhering to these guidelines, you can maintain compliance and avoid unnecessary complications with tax authorities.
And we don’t really like fixing these types of problems because it’s a real pain and it’s very intense for us. Sitting on hold with the IRS is never fun, even if you are getting paid to do it. So please do it the right way. If you have any questions reach out to us.
