Payroll Compliance

Payroll compliance involves meeting federal, state and local legal requirements that regulate employee wages, payroll taxes and related payroll responsibilities. It includes calculating, withholding and remitting payroll taxes, complying with wage and hour requirements, filing required payroll tax forms on time and maintaining accurate payroll records. Employers that fail to meet payroll compliance requirements may face IRS penalties, back-pay liability, state-level fines or other legal consequences. 

Payroll compliance touches almost every part of the payroll process, from paying employees accurately to filing taxes on time. Understanding the definition makes it easier to recognize common payroll risks before they lead to costly errors or penalties. 

What Laws Govern Payroll Compliance? 

Payroll compliance is largely guided by three federal laws that govern employee pay, payroll taxes and unemployment taxes. Together, they establish many of the core requirements employers must follow. State and local laws also add their own rules for minimum wage, overtime, pay frequency, withholding and payroll tax filings.

Note: Not every payroll law applies to every employer in the same way. Specific obligations vary based on factors such as workforce size, employee locations and payroll practices.

What Are an Employer's Core Payroll Tax Obligations?

Employers generally follow the same process each time they run payroll: calculate, withhold and remit certain payroll taxes. This involves determining the correct tax amounts, withholding applicable taxes from employee pay, contributing the employer's share when required and sending those funds to the appropriate tax agencies. Employers are also responsible for completing required payroll tax filings and submitting payroll tax deposits on time. 

Some payroll tax obligations are shared between employers and employees, while others apply only to one party. For example, FICA taxes are generally shared between employers and employees, while the Additional Medicare Tax applies only to employees, although employers are responsible for withholding it once the applicable wage threshold is reached. 

How often payroll taxes must be deposited depends on the employer's tax liability during the applicable IRS lookback period. Depending on that liability, employers generally follow either a monthly or biweekly deposit schedule.  

Employers generally file Form 941 each quarter to report federal income tax withholding along with Social Security and Medicare taxes, while Form 940 is normally filed annually to report federal unemployment (FUTA) taxes. Employers that miss payroll tax deposit or filing deadlines may face IRS penalties, which may be based on the type of violation and how long the issue remains unresolved.

What Does Payroll Recordkeeping Require?

Accurate recordkeeping is a fundamental part of payroll compliance. Employers generally must maintain several types of documentation to support their ongoing payroll responsibilities. 

These records commonly include: 

• Employee wages. Amounts paid to each employee.
• Hours worked. Regular, overtime and leave hours.
• Payroll taxes withheld. Taxes deducted from employee pay.
• Payroll tax payment receipts. Documentation of payroll tax deposits.
• Timekeeping reports. Records supporting hours worked.
• Pay stubs. Breakdown of wages, deductions and taxes.

Under FLSA recordkeeping requirements and IRS employment tax record retention requirements, payroll documentation generally must be retained for three to four years, depending on the type of information maintained. If an audit, wage investigation or employee dispute arises, complete payroll records can help support an employer's response. 

What Are the Most Common Payroll Compliance Mistakes?

Payroll compliance mistakes often happen during routine payroll tasks, especially for small and medium-size businesses with limited payroll resources. Many employers use a payroll compliance checklist to track recurring deadlines, payroll documentation and other ongoing compliance responsibilities. 

• Misclassifying employees as independent contractors. Independent contractor classification mistakes often stem from misunderstanding the relationship between the business and the worker. Reviewing each role using IRS worker classification guidance before hiring can help reduce classification errors.
• Missing payroll tax deposit deadlines. Relentless payroll schedules and changing tax deposit requirements can make it easy to miss deadlines. Following the applicable IRS deposit schedule and tracking due dates can help keep deposits on time.
• Using outdated withholding tables. Federal income tax withholding requirements change periodically. Using the latest IRS Publication 15-T each year helps payroll calculations reflect current withholding rules.
• Failing to register in states where remote employees work. Hiring employees in another state can create new payroll tax obligations. To avoid compliance issues, review state registration and withholding requirements before a new hire begins working.
• Incorrect overtime calculations. Overtime errors often occur when work hours are tracked incorrectly or employees are improperly classified. Reviewing applicable FLSA overtime requirements can help employers apply overtime rules correctly.
• Maintaining incomplete payroll records. Missing payroll documentation can make it more difficult to respond to employee questions or government audits. Keeping complete payroll records throughout the year provides a clearer history of each payroll cycle.

How Does Multi-State Employment Affect Payroll Compliance?

As businesses grow and remote work becomes more common, employers are increasingly likely to have employees working in different states, even without opening additional offices.  

That shift can affect nearly every aspect of payroll administration, because each state establishes its own rules for minimum wage, overtime, pay frequency, payroll tax withholding, payroll tax filings and employer registration. Some cities and local jurisdictions also set minimum wage rates above the state level, adding another layer of payroll administration. As a result, employers may need to adjust their payroll processes to reflect the specific wage, tax and reporting requirements that apply where each employee works.  

Failing to account for these jurisdiction-specific requirements can result in payroll compliance violations, penalties, back-pay obligations and other enforcement actions.