What is payroll compliance?
Payroll compliance refers to the legal framework that governs how you need to handle your employees’ paychecks, taxes, and benefits.
From making sure you’re calculating employee’s wages and benefits correctly to filing payroll taxes with the appropriate authorities, there’s a lot to consider.
Finally, payroll compliance is not optional; it’s dictated by federal, state, and local employment and taxation law, meaning you can face fines or penalties for non-compliance.
Prioritizing payroll tax compliance
While calculating and filing taxes is not the be-all and end-all of payroll compliance, it’s certainly one of the biggest considerations.
To run a legally-compliant payroll, you’ll need to adhere to:
- Federal tax law and legislation
- State laws (and any variations from state to state)
- Local tax laws dictated by the location of the worker.
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Getting payroll wrong: What happens?
If you fail to ensure compliance with payroll legislation, you can face some serious financial penalties.
- If you miss a tax payment deadline, expect an underpayment penalty from the IRS
- An accuracy-related penalty of 20% can be applied if tax is underpaid due to negligence
- Filing past the deadline without an extension could cost you 5% of unpaid taxes for each month a return is overdue.
Your payroll compliance checklist
With constantly evolving regulations and varying state laws, maintaining accuracy in your payroll process can be a challenge.
To help you manage this complexity, take a look at this payroll compliance checklist.
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Employee and worker classification
Correctly classifying your workers is the first step in maintaining payroll compliance.
As part of the payroll process, you’ll need to ensure you:
- Determine if employees are exempt or non-exempt based on the Fair Labor Standards Act (FLSA)
- the difference between independent contractors and employees, and classify accordingly.
Misclassification can mean you’re not paying your workers the correct amount, which can have a serious impact on that individual.
Not only that, but failing to classify your workers correctly can lead to serious legal and financial repercussions.
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Determining gross pay
Part of payroll compliance involves accurately calculating gross pay. This ensures you’re paying workers correctly and adhering to wage and hour laws.
To determine an employee’s gross pay accurately, you’ll need to ensure you are:
- Tracking hours accurately (including any overtime)
- Calculating pay based on hourly rates or salaries
- Complying with federal and state-specific overtime regulations
- Including any additional earnings, such as bonuses and commissions.
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Calculating deductions
To ensure your payroll is running smoothly (and legally!), you must calculate deductions properly according to all relevant legislation.
Here are some of the deductions you’ll need to withhold from employee’s paychecks to satisfy legal requirements:
- Federal Taxes – Withhold according to IRS guidelines
- State Taxes – Make sure state-specific tax regulations are accounted for
- Social Security and Medicare – Deduct based on current rates
- Benefits Contributions – Don’t forget to include health insurance, retirement plans, and other benefits
- Garnishments – Apply any court-ordered garnishments and child support requirements accordingly.
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Distribution of payments
It may sound pretty obvious, but part of maintaining a fully compliant payroll is actually paying your workers – and doing so accurately and on time.
As part of fulfilling your payroll obligations as an employer, you may want to consider some of the following actions.
- Direct Deposit – Ensure setup and accuracy for direct deposit payments
- Physical Checks – If you’re issuing physical checks, make sure they’re distributed promptly
- Electronic Payments – Check you’re complying with regulations governing electronic payment methods.
After all, delays or errors can not only violate labor laws – mistakes can erode employee trust and tarnish your reputation as an employer.
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Tax filings and compliance
Payroll tax compliance relies on you submitting timely and accurate tax filings for both your company and your employees.
The payroll tax laws you’re going to need to look out for are:
- Federal tax filings, including forms like 941, 940, and W-2s on time
- State tax legislation that complies with state-specific filing requirements
- Local tax obligations, such as city or county taxes
- If you employ workers based in other countries, you will need to file taxes relevant to that country.
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Record-keeping and payroll auditing
Keeping detailed records and conducting regular payroll audits is an essential part of payroll compliance.
Here are the key actions you need to take to ensure payroll compliance:
- Record keeping maintain and store accurate employee and payroll records, including Form W-4 for tax withholding. Make sure they are stored safely and go back at least 3 years.
- Payroll process audits – Perform regular internal audits of your payroll process. This will help you identify and correct discrepancies.
- Documentation – Keep documentation of payroll policies and procedures. Ideally, make this documentation available to workers and in-house payroll teams.
Poor record-keeping or failure to adhere to new or existing legislation can result in penalties and fines.
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End-of-year reconciliation
Reconciliation at the end of the year is a key part of payroll compliance, helping to ensure all payroll information is accurate and complete.
End-of-year payroll reconciliation typically includes:
- Ensuring all W-2 forms are correctly filled out and distributed
- Preparing and distributing 1099 forms for independent contractors
- Generating and reviewing year-end payroll reports.
Frequently Asked Questions (FAQs)
Learn more about payroll risk management and how you can help maintain a compliant payroll with these frequently asked questions.
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Payroll laws and legislation are in place to ensure workers are paid the correct wage or salary, on time, and in the correct format.
US Payroll law provides employers with a framework to pay their workers and submit the correct amount of tax. This can include federal, state, and local regulations, which in turn dictate workers’ wages, taxes, and employee benefits.
The Internal Revenue Service (IRS) manages payroll tax laws, including the collection of federal income tax, Social Security, and Medicare taxes.
Additionally, state-specific laws may set different minimum wage rates, overtime rules, and additional payroll tax requirements.
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A payroll compliance practitioner ensures that an organization’s payroll processes adhere to all relevant laws and regulations. Their duties can include:
- Keeping up-to-date with changes in payroll laws
- Accurately processing employee wages and deductions
- Ensuring timely filing of payroll taxes and annual payroll reports
- Preparing for and responding to payroll audits
- Addressing employee queries related to payroll and taxes.
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Payroll compliance legislation refers to the laws and regulations that govern how businesses must handle payroll. In the US, this includes:
- Federal Laws – Affecting every state in the US, such as the Fair Labor Standards Act of 1938 (FLSA) and IRS regulations.
- State Laws – State-specific legislation, which can include varying minimum wage rates and state income taxes.
- Local Ordinances – Additional laws dictating payroll and tax compliance that may apply at the city or county level.
Compliance with these laws is essential to avoid penalties and ensure employees are paid fairly and accurately.
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Statutory compliance in payroll describes the laws and regulations employers must adhere to when paying their workers and submitting taxes.
When it comes to payroll, compliance is statutory; meaning it’s legally required. It’s up to each employer to ensure they’re not breaking payroll law as they calculate and run payroll.
Some of the biggest payroll compliance concerns include:
- Properly deducting the correct amount of federal, state, and local taxes from employee wages
- Managing contributions to Social Security, Medicare, and other benefits
- Complying with wage and hour laws, including minimum wage and overtime regulations.
Failure to comply with statutory requirements can result in legal penalties and reputational damage.
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When looking at how you run an accurate and compliant payroll, it can help to remember why our taxes are so important and who they benefit.
At the federal level, payroll taxes help fund:
- Social Security – Providing retirement, disability, and survivor benefits to millions of Americans.
- Medicare – Healthcare for individuals aged 65 and older and certain younger people with disabilities
- Unemployment Insurance – Supporting workers who lose their jobs
Local taxes support services and infrastructure directly impacting the community. By ensuring a compliant payroll, you’re helping to fund schools, public safety, and public roads and services.
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California has some of the strictest payroll tax compliance laws in the U.S.
If you employ people in California or are looking to expand at some point, you’ll need to know about:
- Final Paycheck Law – Employers must pay final wages within 72 hours of termination or immediately if the employee gave at least 72 hours’ notice
- The Wage Theft Prevention Act of 2011 – Much like New York, California has legislation in place that heavily penalizes employers for failing to pay employees properly
- Unemployment Insurance Tax – Employers must contribute to the state’s unemployment insurance fund.
If you fail to comply with laws and legislation like this, you could be facing significant fines or even legal ramifications in the state of California.
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