Maintaining payroll compliance is essential for protecting your business from liability. But with so many federal, state and local payroll laws to follow, it can be tough to know how to stay in compliance. Read on to discover best practices for maintaining payroll compliance and the must-have components of payroll compliance.

What is payroll compliance?

Payroll compliance involves following each federal, state and local regulation that governs how employees are paid. If you violate any of these payroll laws, your business may be subject to serious consequences, including penalties and fines.

Why payroll compliance is important

Having non-compliant payroll can mean serious consequences for your business. Improperly paid taxes can lead to audits and fines from government agencies, in addition to penalties and interest on late or unpaid payroll taxes. You might also be subject to legal expenses if you are ever taken to court for non-compliant payroll. You will also have to back-pay any missing wages to employees.

Payroll compliance best practices

Understand all relevant laws

To ensure your payroll is compliant, you need to understand all applicable federal, state and local payroll laws — and international laws too, if you are paying employees outside the United States. Some of the most important federal laws to know are the Fair Labor Standards Act (FLSA), Federal Insurance Contributions Act (FICA), Federal Unemployment Tax Act (FUTA) and the Equal Pay Act (EPA). State and local laws vary by jurisdiction.

Calculate wages and withholdings correctly

The first step to payroll compliance is ensuring employees are paid correctly. If their wages are incorrect, then your withholdings, deductions and tax payments will be incorrect as well. Confirm that employees’ salaries and pay rates are entered correctly and that you have correctly calculated for overtime as well. Thresholds and contributions also update each year, so you’ll need to adjust your figures accordingly before calculating payroll taxes.

File the correct taxes with the right tax agencies on time

After you’ve calculated the correct amount for various taxes, it’s time to file them with the appropriate federal, state and local tax agencies. Business payroll taxes are usually due once a quarter: Check the IRS website for this year’s due dates. We recommend setting calendar alerts several business days in advance so that you don’t fall behind on payroll compliance.

Consider using payroll software

Filing taxes manually is a time-consuming headache, and it increases the chances of human-caused errors. Payroll software such as Gusto can save you time and increase accuracy by automating the process, ensuring employees are always paid on time and that taxes are always filed correctly. Check out our list of the best payroll software to jumpstart your search.

Key components of payroll compliance

Employee classification

How an employee is classified determines what payroll laws and taxes apply to them, so proper employee classification is essential. Know whether each worker is an employee or an independent contractor, and if the employees are either exempt or nonexempt.

Federal wage and hour laws

Some of the federal wage and hour laws you need to adhere to include federal minimum wage, overtime pay and exemptions, work hours and meal breaks, and child labor. You must also keep accurate records — including payroll and timekeeping — for both exempt and nonexempt employees.

State wage and hour laws

True to the name, these wage and hour laws vary by the state your business is based in. Some states mostly follow federal labor laws, while others (such as New York and California) have enacted additional legislation and minimum wage limits that businesses must follow. Many states also have specific laws concerning issues not addressed through federal laws, such as final paychecks and pay stubs.

Wage garnishments

Title III of the Consumer Credit Protection Act (CCPA) sets federal wage garnishment limits for alimony, child support and consumer debts. However, some states have lower garnishment thresholds than the CCPA does, so check your local regulations to be sure. Businesses must also comply with separate laws that govern federal student loans and IRS wage levies.

Employee benefits and deductions

Different payroll rules apply to pre-tax benefits, post-tax benefits and mandatory paid time off. You must comply with all of these laws to ensure accurate deductions are taken out at each step of the payroll process to maintain compliance.

Federal employment taxes

Employers are required to withhold numerous payroll taxes from employees wages, like Social Security, Medicare and federal income tax. Employers must also pay their own share of all three of these taxes.

State and local employee taxes

Most states require that you withhold income tax from employees’ wages, and you may need to withhold money for other state taxes as well. The employer must also pay state unemployed taxes in addition to other business taxes legislated by the state. A few localities also impose additional taxes on employers.

Payroll reporting

To remain compliant, your business must file payroll reports with various federal, state and local tax agencies. Some examples of these reports include Form W-2 reporting, federal employment tax reporting, state wage and tax reporting, and local wage and tax reporting.

Frequently asked payroll compliance questions

What is the best practice for payroll?

Some best practices for payroll include understanding all applicable payroll laws, calculating the correct wages and withholding, filing the correct taxes with the right agencies and using payroll software.

How do you maintain payroll accuracy?

To maintain payroll accuracy, frequently update your employee record and double-check all data entry for error. If you decide to implement payroll software like Gusto, you should train your payroll team on how to use it and update the software frequently to ensure that new laws are loaded into the system.

What is the meaning of payroll compliance?

Payroll compliance means following each federal, state and local regulation that governs how employees are paid.

How do you manage payroll effectively?

To manage payroll effectively, you must collect and update employee data, calculate gross pay and deductions, determine employer tax contributions, and pay both your employers and the various tax agencies. For more information, see our guide that explains how to do payroll.