Let’s start from the basics. Payroll compliance is the act of following the laws regarding hiring employees, reporting earnings, treating the workers fairly, and managing payroll taxes. Misclassifying employees as independent contractors is a common payroll compliance mistake. Sometimes, businesses make this mistake in ignorance, while others do so to minimize labor costs.
In 2023, California Senator Steve Padilla wrote to the state Labor and Workforce Development Agency requesting it to open an investigation against Deel, a fintech-turned-HR startup. Padilla alleged that Deel misclassified employees to evade taxes, raising serious payroll compliance concerns related to denying workers benefits such as workers’ compensation, overtime pay, healthcare, retirement, unemployment insurance, collective bargaining, and more.
The Deel case teaches us how violations of payroll compliance laws and regulations, including employee misclassification, can lead to investigations, penalties or lawsuits.
By following payroll best practices and working with experienced payroll professionals, you can mitigate these risks effectively. Let’s dive into those key areas that ensure compliance with payroll laws and regulations.
1. Payroll Taxes
Payroll taxes are withheld from employees’ paychecks and paid by employers to fund vital government programs for retirees, people with disabilities, and others in need.
Failure to withhold, deposit or report these taxes correctly can result in payroll compliance violations with serious penalties. These include fines of 2% to 15% for a late payment. In cases of willful non-compliance, there is a 100% penalty on unpaid taxes, possible criminal charges and fines up to $10,000 or imprisonment.
Withholding Payroll Taxes
Payroll tax withholding first identifies each taxable employee and excludes independent contractors who pay their taxes independently. To secure payroll tax compliance, the employees pay payroll taxes through the deductions of federal, state, and local taxes taken from their paychecks.
They are considered payroll taxpayers since employers manage their work conditions, finances, and relationships in many ways. Independent contractors operate independently and, at times, serve different clients.
After identifying your taxable employees, calculate their taxable wages, including salaries and bonuses, but make sure to exclude verified business reimbursements.
Filing Tax Reports
Another important requirement to satisfy payroll compliance is for employers to submit tax reports. These reports reveal taxes paid and withheld—income, Social Security, and Medicare.
The Employer’s Quarterly Federal Tax Return (Form 941) is filed quarterly to the Internal Revenue Service (IRS) for federal reporting. This includes the wages paid and the federal income tax withheld.
Some annual tax return requirements involve the Wage and Tax Statement, form W-2 for every employee, which summarizes all wages, tips, and withholding taxes. It must be filed with the Social Security Administration (SSA) and state and local tax agencies by January 31. A copy also needs to be furnished to the employee.
2. Time and Attendance
A payroll compliance checklist correctly accounts for time and attendance since overtime hours must be paid correctly to the workers. However, record-keeping requirements must also be satisfied for regulatory compliance.
Compensating Employees Properly Based on Accurate Time and Attendance Recording
With precise time and attendance tracking, employees are paid based on their actual working hours. This helps keep payroll compliance with labor standards.
Accurate and reliable systems and procedures capture all needed data, including working hours, overtime, leave, absence, and break times, to produce a detailed amount owed to each employee.
Without these tools, you risk payroll compliance issues including underpayment, overpayment, time theft, and wage violations. The American Payroll Association revealed that manual tracking errors can cost up to 7% of the business’s total payroll.
3. Labor Laws and Regulations
Labor laws and regulations ensure that employees receive fair wages while protecting their rights. Covering payroll compliance essentials like minimum wage requirements, wage calculations, tax withholdings, social security, and benefits, these laws highlight your commitment to ethical employment practices.
Payroll compliance, however, requires navigating labor regulations’ complexity and frequent updates. Labor laws are constantly dynamic because they evolve with changes in socio-economic conditions, technology, and societal values.
Remaining compliant with payroll means consistently updating your payroll processes to meet current regulations.
4. Onboarding
Onboarding is a crucial element of payroll compliance, since it’s important to collect and manage important data from new hires. As part of the onboarding process, employees typically complete forms like the W-4, which helps build their payroll profile.
Errors like incorrect payroll tax withholding or missing forms can lead to unexpected tax bills for employees and may incur IRS penalties for your business.
In 2020, the IRS reported that small businesses paid an average of $845 in fines each year for payroll tax filing errors, including late submissions and inaccuracies in tax withholdings or reporting. Effective payroll for small businesses is especially important to prevent these costly mistakes and maintain compliance from the start.
5. Training
Mandatory employee training helps you fulfill legal obligations and maintain payroll compliance while creating a safer and more productive workplace. The type of training required varies by location, industry, and employee roles.
For instance, sexual harassment prevention training, espoused by the Equal Employment Opportunity Commission (EEOC), is mandated in some states for employers employing five or more employees. Industry-specific training is often also required. Under the Hazardous Materials Regulations, for instance, workers must be trained specifically on handling hazardous substances, and in health care services, employees must be trained on handling patients’ data as required by the Health Insurance Portability and Accountability Act (HIPAA).
Accurate hours of training are necessary because they define job classifications, wages, and entitlement to hazard pay and prevent costly payroll compliance errors or legal issues.
Key Takeaway
By gaining insights into these five key areas and best practices in payroll compliance, you can avoid costly mistakes like late payments, inaccurate tax filings, and disorganized payroll records. Any case of payroll non-compliance entails risks of back pay charges in wages, audits, fines, penalties, and legal fees.
It can also hurt employee morale, driving up turnover and decreasing productivity, which increases hiring costs.
The consequences of poor payroll compliance practices can be severe. Proactively managing compliance and working with a vendor you can trust shields your business from these financial burdens and creates a more positive work environment, ultimately saving time, money, and resources in the long run.
