Payroll compliance: Laws, importance, and best practices

When it comes to payroll taxes, managing the administrative tasks associated with correctly calculating and withholding payments can feel daunting enough, let alone staying current on the complex rules that govern when, how, and how much your organization needs to pay.

Standardizing your organization’s approach to payroll and developing a framework for reviewing and updating your procedures creates a strong foundation you need for peace of mind. The suggestions below can help you

What is payroll compliance?

Payroll compliance refers to the processes your organization uses to ensure that it adheres to all applicable laws and regulations regarding employee wages, tax withholdings, overtime pay, benefits, record-keeping, and other aspects of pay and payroll. It also involves making sure all workers are paid correctly and on time and that all payroll taxes are reported and paid to the correct agencies by the correct due dates.

Typically, payroll compliance focuses on meeting your tax obligations, but can also touch on the following:

• Data protection. Depending on location, it matters how and to what extent your organization discloses employee data to government agencies.
• Employee classification. Correctly categorizing workers as employees or contractors has significant implications for mandatory tax withholdings and unemployment insurance contributions.
• Wage calculation. Most jurisdictions have laws to ensure that workers receive a minimum level of compensation and specific formulas for calculating pay.
• Payroll tax reporting. Depending on your organization's size and tax status, you’ll pay your mandatory payroll taxes quarterly or annually. 
• Pay equity. In jurisdictions that require employers to report on employee demographics and wages, collating and storing this information becomes part of payroll reporting and compliance.
• New hire registration requirements. Registering your new hires correctly helps ensure accuracy in withholding and payroll tax calculations. 

4 common payroll compliance mistakes 

Because payroll compliance requirements vary across different jurisdictions, organizations—particularly those with remote or distributed workforces—may find it challenging to develop and implement procedures that comply with all the relevant laws. When thinking about the resources you need to design an effective payroll compliance policy, consider these common mistakes.

Failing to stay current on rules and regulations

From the due dates and withholding rates to forms and submission methods, the regulations that govern how organizations withhold and submit payroll taxes and other requirements for payroll compliance are many—and change frequently.

Without regular reviews to ensure compliance with the most recent requirements, your organization risks a late or incorrect filing.

Missing deadlines for payroll reporting

In the US, the IRS imposes monetary penalties and charges interest for late payroll tax reporting and payments. Regulators in other jurisdictions often use similar tools to ensure proper withholding and prompt remittance of an employer’s share of contributions to social security, healthcare, and insurance programs.

To avoid penalties, an effective payroll compliance system should incorporate ample time to prepare important reports and forms and multiple reminders to file and pay. Banking tools like automated withdrawals can also help.

Misclassifying employees and independent contractors 

Incorrectly categorizing workers as employees or contractors can impact how your organization calculates payroll tax withholdings, potentially leading to stiff consequences. In cases where the IRS believes an organization has willfully—rather than negligently—misclassified workers to avoid making social security and FUTA contributions, for example, penalties can include criminal charges. 

If reviewing the Fair Labor Standards Act (FLSA) doesn’t answer your questions about worker classification, consider consulting a legal expert specializing in employment. If all else fails, you can file a Form SS-8 with the IRS to request clarification directly from the agency.

Completing the wrong IRS form

The IRS uses different forms to report different information, and completing the wrong one can lead to delays and penalties. You wouldn’t, for example, want to report payments made to an independent contractor using Form W-2 (the wage and tax statement for employees), or report FICA taxes withheld on a Form 940 (the form for reporting employers’ annual FUTA contributions). 

To understand which forms your organization needs to complete—and for which employees—start with how your workers are classified, or whether you need a form for an employee or an independent contractor. This will help you understand how to report compensation paid and the necessary withholdings. Once you’re clear on what to report, you can focus on matching the information to the proper IRS form. The IRS Forms & Instructions page is also helpful for finding the right paperwork.

Essential payroll laws & regulations

To fully understand the extent of your organization’s payroll tax obligations as an employer, familiarize yourself with some key statutes. Note that this isn’t an exhaustive list; a legal or tax professional can provide further guidance.

Payroll compliance in the US

US employers have laws at the federal, state, and local levels, as well as a mix of labor, employment, and payroll tax compliance mandates from government agencies like the IRS, Department of Labor (DOL), and Equal Employment Opportunity Commission (EEOC). Here are a few key US statutes to know.

Federal Insurance Contributions Act (FICA)

FICA requires employees and employers to contribute to the Medicare and Social Security programs through payroll taxes. Under this law, eligible workers receive retirement, healthcare, and disability benefits. 

Federal Unemployment Tax Act (FUTA)

Under FUTA, employers must contribute to federal and state unemployment insurance programs that support qualifying workers following a job loss. 

Federal Income Tax 

Employers withhold a portion of every W-2 employee’s paycheck and remit it to the IRS on their behalf to cover individual income taxes.

Fair Labor Standards Act (FLSA)

The FLSA sets minimum standards for employers regarding wages, hours, and overtime pay. The law also includes some important recordkeeping requirements.

Equal Pay Act (EPA)

The EPA applies to any employer subject to the FSLA and mandates that employees performing substantially similar duties should receive approximately the same pay—with exceptions for experience and merit. 

State and local laws

Provided they meet the minimum requirements set out by federal statutes like the FLSA and the EPA, state and local governments have the right to enact employment laws and regulations relating to minimum wage, overtime, paid leave, and other aspects of employment.  

Global payroll compliance

Outside the United States, international jurisdictions also require businesses to make payroll deductions and report income to local authorities. If your business employs workers abroad, consult a legal or tax professional to learn how to pay your workers properly.  

European Union Working Time Directive (WTD)

The European Working Time Directive (WTD) applies to any country within the EU and governs working hours, break times, and paid leave. Note that this law, like all EU laws, sets a minimum standard for member states, and individual countries may have more specific rules.

Labor Law of the People’s Republic of China

The Labor Law of the People’s Republic of China sets minimum wage and working hour requirements for employers in China. It also specifies when and how employers should calculate deductions and withholdings. 

Canada Labor Code

In addition to wage and hour rules, the Canada Labor Code regulates termination and severance pay, paid leave, and overtime. The statute also includes provisions related to pay equity.

The risks of payroll non-compliance

Failure to comply with applicable payroll regulations can come with a hefty price tag. 

Regulators typically assess a monetary penalty that amounts to a percentage of what your organization owes. In the US, for example, the IRS may fine you up to 5% of the amount your organization owes. You’ll also need to pay the affected employees any wrongly withheld or miscalculated wages directly.

The consequences may be more severe when regulators believe your organization acted intentionally to avoid paying payroll taxes. In some jurisdictions, executives and decision-makers can face criminal charges for willfully disregarding payroll laws,  in addition to personal financial penalties. 

Payroll compliance: 6 best practices

Fortunately, most organizations can avoid payroll compliance errors by instituting regular policy and procedure reviews or by investing in dedicated software that automates tasks like preparing forms, calculating deductions, and filing payroll taxes. 

Use payroll software

With payroll software like Rippling, you can run payroll accurately and on time, every time. That’s because we built Rippling’s payroll software on a single source of truth of employee data, so it can automate manual work and reduce the risk of human error. With Rippling’s 100% error-free guarantee, you just click “Run,” and Rippling automatically calculates your payroll taxes and files them with the right federal, state, and local agencies at the right time, every time.

Use a compliance calendar

If you’re not able to automate the payroll process, consider using a team calendar or other tool to create a series of reminders to initiate important tasks, such as collecting information or documents and compiling reports. Having an accessible visual record of when specific forms and filings need to be completed and filed can also help your team develop efficient processes and coordinate with stakeholders in other departments, where needed. 

Stay up to date with payroll legislation

Many regulators release periodic bulletins announcing changes in payroll tax requirements, and signing up to receive these and other industry-specific publications can help keep your organization ahead of the curve. Alternatively, some payroll solutions automatically update your team of new requirements and guide you through the steps to take to remain compliant. 

Verify employee classifications 

Workers change roles within organizations, and restructurings can lead to substantive changes in the duties and responsibilities associated with a position. Regularly reviewing your classification process and auditing existing work classifications ensures that you’re properly withholding payroll taxes where applicable.

Perform audits regularly

Regularly reviewing your internal processes around onboarding and payroll can prevent compliance errors at the source. Even automated workflows, which reduce the risk of human error, can improve with regular human inputs. If, for example, you know your state intends to implement new rules around payroll tax filing, an advance review of your existing approach gives your HR professionals time to make any needed changes. 

Consult experts

If you’re struggling to develop a comprehensive compliance process or can’t find a reliable answer to an important question, consult a legal or accounting professional. Not only do you benefit from specialized knowledge and training, but lawyers, accountants, and other licensed advisors can share in your compliance risks. 

Alternatively, partnering with a professional employer organization offers dedicated assistance on a range of HR issues. With Rippling PEO, you benefit from round-the-clock access to HR experts who stay current on employment laws and best practices. 

Payroll compliance checklist 

Once you’ve determined the best practices that govern your organization's approach to payroll compliance, it’s time to develop specific workflows to manage payroll tasks and administration.

Incorporating the following steps into your employee onboarding and payroll management processes can help protect your organization from costly missteps:

• Classify employees correctly. Determine whether a worker qualifies as an employee or a contractor according to the relevant laws in their jurisdiction. Our free worker classification analyzer can help.
• Add new employees to a payroll system. Collect the proper tax forms from all new employees and ensure that their information has been entered correctly in your payroll and accounting software.
• Adhere to overtime pay and minimum wage laws. Review relevant laws on overtime pay and minimum wage to ensure you’re compensating workers appropriately.
• Maintain accurate payroll records. Keep detailed records of all payroll transactions, including hours worked, wages paid, and benefits or taxes withheld.

Automate payroll compliance with Rippling

Rippling Payroll is intuitive, easy to use, and has a 100% error-free guarantee on every pay run. It also offers 500+ integrations, automatic and accurate tax registration and filing, and a dedicated mobile app where your employees can view their W-2s and paystubs, submit expenses directly, and more. With Rippling, you can: 

• Pay employees and contractors in the same platform
•  Manage time and attendance natively 
• Run unlimited off-cycle pay runs at no extra cost 
• Set up multiple pay schedules, pay rates, and pay types in just a few clicks 
• Add recurring reimbursements (like cell phone payments, gym memberships, etc.) that are automatically paid out every pay period, monthly, or at whatever interval you choose
• Automatically calculate prorated pay runs for new or promoted employees 
• Manage all currency conversions, including payroll adjustments 
• Automatically calculate overtime for every country 
• Make changes after submitting payroll

FAQs on payroll compliance

How to maintain payroll compliance?

Maintaining payroll compliance involves several important steps. First, correctly classify your worker as a W-2 employee or a 1099 contractor in order to properly calculate wages and withholdings. Next, ensure that your organization remains current on payroll tax rules and regulations and updates its policies as-needed. Finally, invest in software and other tools to automate the reporting, filing, and payment process to stay ahead of key deadlines. 

What is a payroll compliance audit?

A payroll compliance audit is a process used by organizations to review existing payroll policies and procedures against current laws and make any necessary updates or improvements to avoid penalties. Generally, a payroll compliance audit will examine how an organization classifies its workers, calculates wages, completes mandatory filings, and stores sensitive information. 

What is the role of a payroll compliance manager?

A payroll compliance manager is responsible for ensuring that an organization’s payroll procedures comply with all applicable laws. In addition to overseeing payroll systems and monitoring tax filings, a payroll compliance manager may also conduct trainings and coordinate with in-house counsel to develop handbooks and policy documents.

This blog is based on information available to Rippling as of September 25, 2024.

Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.