Stay on the right side of the law with this payroll compliance guide

The thing about payroll is that minor errors can snowball into hefty fines, unexpected audits, and even a lawsuit. And before you know it, your business falls into legal and financial troubles.  

Payroll compliance is a lot more than just paying salaries on time. From correctly classifying employees in accordance with federal laws to withholding the right amount of taxes and making accurate overtime payments, payroll compliance is a continuous process, an ongoing commitment to keep your business secure.  

With the increasing complexities and ever-evolving regulations, mistakes are bound to happen, even when you have the best of intentions.  

We are here to make your payroll compliance journey a bit easier.  

By understanding payroll compliance and everything it entails, avoiding common mistakes, and implementing best practices, you can build a payroll system that’s both efficient and legally sound. Besides, by learning about payroll analytics, you will understand how data can help you make smart decisions and solve your payroll problems.  

Let’s break it down in this blog.  

Understanding payroll compliance 

Payroll compliance is the process of adhering to federal, state, and local regulations that govern areas like employee compensation, tax withholdings, benefits, recordkeeping, and many more.  

With payroll compliance, the key objective is to ensure your employees continue receiving correct and timely pay, proper employee records are maintained, taxes are reported accurately by their due dates, and all other legal requirements are met.  

For U.S. businesses, this means complying with laws such as the Fair Labor Standards Act (FLSA), Family and Medical Leave Act (FMLA), and other local regulations.  

Key focus areas of payroll compliance:  

• Proper classification of employees as full-time, part-time, or contractors
• Timely reporting and submission of taxes to authorities 
• Accurate calculation and withholding of taxes  
• Ensure employees receive the minimum compensation set by the laws 
• Accurately calculating wages considering overtime rates 

When you comply with payroll laws and regulations, you create a win-win situation where both your business and employees can benefit.  

The legal side of payroll: Key U.S. laws and regulations 

At Hobasa, we believe that before you start working toward your payroll compliance responsibilities, it’s essential to have a good understanding of the related laws and regulations. Listing some of these below:  

Fair Labor Standards Act (FLSA)  

The FLSA establishes minimum wage, overtime pay eligibility, and record-keeping requirements.  

Federal Insurance Contributions Act (FICA)  

FICA is a U.S. federal tax that requires withholding of taxes to fund the Medicare and Social Security programs of employees. These programs take care of employees’ retirement, health, disabilities, and even children of deceased workers.  

Family and Medical Leave Act (FMLA)  

This U.S. federal statute ensures job-protected, unpaid leaves for eligible employees for family and medical reasons, without any changes in the terms and conditions of the individual’s group health insurance coverage.  

Equal Pay Act 

The EPA prohibits wage discrimination based on gender. It mandates that all employees doing equal work should be paid equally. This covers salaries, bonuses, overtime pay, reimbursements, and other benefits.  

Federal Unemployment Tax Act (FUTA) 

According to FUTA, employers are required to contribute to state unemployment insurance agencies, to support individuals when they go jobless.  

Federal Income Tax 

Employers are required to withhold federal income taxes from employees’ paychecks based on W-4 forms and IRS guidelines.  

The risk and cost of payroll non-compliance  

Payroll non-compliance can land you in not just legal but also financial troubles. Not to forget the damage payroll errors can inflict on your company’s hard-earned reputation.  

Let’s talk about the financial repercussions first as they can have a more immediate impact on your business.  

In 2024, the U.S. Department of Labor obtained a judgment from the federal court to recover a staggering amount of $1million from businesses due to:  

• Failing to pay minimum wage to some employees
• Inaccurate or incomplete records of wages, hours, etc. 
• Failing to pay overtime wages for employees who worked more than 40 hours a week 

This shows that intentionally disregarding the law can come with a costly price tag.  

Additionally, there can be hefty fines from the IRS when there are late or incorrect tax payments, further straining the budget.  

What follows is a long, exhausting, and financially draining legal battle, employee dissatisfaction, and negative attention from the press.  

Simply put, the cost of ignoring payroll compliance significantly outweighs the investment in getting it right.  

Payroll mistakes that can lead to non-compliance

There are some common payroll mistakes that organizations tend to make, eventually falling into the trap of non-compliance. Let’s take a glance at them:  

Employee misclassification 

Incorrect classification of full-time employees as independent contractors to evade taxes, or make FUTA contributions, can backfire, leading to hefty penalties by the IRS. This is especially the case when the IRS believes this violation was done willfully and not due to sheer negligence.  

Another common employee misclassification mistake is with regard to exempt and non-exempt status. As per FLSA, only non-exempt employees are eligible for overtime pay. Most organizations assume that salaried employees are exempt from overtime pay. However, that’s just one of the criteria.  

It’s important that you check employees’ eligibility for exemption under FLSA, otherwise, misclassification can lead to lawsuits and penalties.  

Inaccurate recordkeeping 

Another employee payroll mistake that can lead to non-compliance is incorrect or incomplete recordkeeping. Keeping payroll documentation and records of existing employees as well as those who have left is paramount. This acts as essential proof of compliance whenever there is an audit.  

For long-term accessibility and security, it’s best to have payroll details recorded in cloud-based systems. This way you can get the data at your fingertips and ensure smooth payroll management.  

Missing out on tax deadlines 

Most taxes have a cumbersome filing process and different deadlines, making it difficult to stay on track.  

For example,  

You are required to withhold federal income tax, social security tax, and Medicare tax from employees’ salaries and remit that amount along with your share of taxes. These taxes need to be deposited at specific intervals as laid out by the IRS.  

The same goes for forms.  

Form 941 is to be submitted every quarter, while Form 940, submission is to be made once a year. Form W-2 and 1099, submissions should be made to both IRS as well as employees, once a year.  

IRS has strict schedules for tax filings and payments and failing to adhere to these can land you in a legal mess.  

Inaccurate calculation of tax on employee benefits 

Another mistake that can affect employee payroll and lead to non-compliance is the incorrect classification of benefits as taxable and non-taxable.  

While benefits like health savings account contributions are tax-free, taxes are levied on stock options and fringe benefits such as discounted flights, vacations, and other services. 

Regular review of employee benefits programs and their tax implications is necessary to ensure you stay on the right side of the law. It’s also important to withhold the right tax amount from your employees’ pay and report them on the right forms. 

Failure to stay updated on the latest rules and regulations 

Another critical aspect of payroll compliance is keeping up with the ever-changing landscape of laws and regulations. Failing to stay current with these changes can make your business vulnerable to the risks of non-compliance.  

The regulations regarding the payroll tax due dates, tax withholding rates, and even form submission methods can change anytime. You need to have a full-fledged system that enables you to regularly review the changes happening at the federal, state, and local level regulations, to ensure your payroll practices are up to date.  

Best practices for navigating the complex world of payroll compliance 

Navigating the complex web of laws for payroll compliance can feel overwhelming. There is always the fear of going wrong and attracting severe consequences, even when you have the best intentions.  

Equipped with these best practices, you will become more confident in managing employee payroll compliance. 

Create a payroll calendar 

Staying compliant means never letting a deadline slip through the cracks. Keeping a close track of due dates and forms to be filled is a laborious and time-consuming task, with a great chance of your team missing out on something or the other.  

Creating a payroll calendar can take the burden off your team’s shoulders. With a well-maintained calendar, your team can keep a close eye on tax filing, deposit deadlines, and employee pay schedules, in a financial year.  

The calendar will help you stay proactive with your submissions, minimizing the risk of non-compliance and legal hassles.  

Conduct regular audits 

Regular internal reviews of your payroll system help in identifying discrepancies or outdated practices that are not in line with the new rules.  

Such audits ensure that no important rules, deadlines, or processes slip through the cracks and that there is a high level of accuracy in employee classification, tax withholdings, and benefit calculations.  

For example, when restructuring happens, there are role changes within the organization. A thorough and regular check of your existing employee classification will help ensure that the right taxes are being cut, as per employees’ status.  

With these audits, it’s easy to catch errors early on, take corrective actions on time, and save your business from costly penalties later.  

Maintain comprehensive and centralized records 

When you have a meticulous, up-to-date record of your employees’ pay, hours worked, tax withholdings, salaries paid, and benefits offered at a single location, fetching information becomes a breeze. Also, comprehensive records aid in simplifying the audit process, as your team doesn’t have to take the pain of going through scattered files.  

These records should be updated from time to time, when an employee exits, goes on paternity or maternity leave, or gets a hike or promotion. As these events have a direct impact on payroll, it’s crucial to ensure they are incorporated into the records.  

Stay current with the latest laws and regulations 

It’s easy to lose track of the changes happening in the laws and regulations at the federal, state, and local levels if you don’t have a systematic process in place for your team to receive updates.  

Staying current with these laws is essential as it helps your team alter the payroll practices to ensure they are in line with the changes.  

There are multiple ways your teams can stay in the loop of what’s happening in the legal landscape. Subscribing to newsletters, attending industry webinars, and signing up for updates from the Department of Labor and IRS can be of tremendous help.  

Ensure accurate wage calculation 

Payroll errors also arise due to incorrect calculation of wages, especially when employees work overtime, and receive a hike or bonus. Such errors can result in underpayment or overpayment, leading to risks of non-compliance and legal woes. 

To prevent such errors, ensure that your team applies the right wage rates for different employee categories, calculate the overtime pay correctly, and take extra care when calculating deductions as some of these are taxable and some are not.  

For example,  

FLSA mandates companies to provide non-exempt employees overtime pay at the rate of 1.5 times their regular pay for any number of hours worked above 40 in a particular workweek.  

Having a full-fledged team that can keep track of such regulations is a great way to maintain precision in wage calculations and avoid compliance breaches.

Take guidance from payroll and compliance experts  

Payroll compliance can get overwhelming and sometimes even a single mistake can burn a hole in your wallet due to costly fines, legal repercussions, and back payments. Given the fact that such laws are complex and get updated frequently, taking expert guidance can prove helpful for your team.  

With the help of experts, your team can get access to specialized, in-depth knowledge about the subject. Your team will also gain clarity around the gray areas, where confusion is likely. For example, the taxability of certain employee benefits might not always be straightforward.  

Experts can also help your team make sense of the frequent changes happening in the payroll compliance space, enabling you to correctly interpret new regulations and optimize your processes.  

The power of payroll analytics for staying compliant 

At Hobasa, we believe in the power of taking the right actions at the right time.  

With the help of payroll analytics, you can get detailed and real-time insights into your payroll process, which makes it easy to identify gaps and errors before they escalate. This helps prevent recurring instances of overpayment and underpayment, saving you from legal repercussions.  which

With insights into employees’ working hours, leave usage and balance, benefits offered, overtime, employee classification, and tax withholdings, your team can take necessary actions to stay compliant.  

For example,  

Using payroll data analytics your HR staff can have a quick view of overtime work hours by employees and check if it’s exceeding the legal limits. You can also identify discrepancies in classifying employees as full-time, part-time, independent contractors, exempt, and non-exempt, and ensure adherence to the rules set by FLSA.  

Besides, payroll analytics can give your team quick updates on any changes in labor laws or tax regulations, and new mandates by the IRS, helping them make relevant changes in the payroll process.  

If done manually, these things can consume more time and money. Payroll data analytics and reports can simplify the process by equipping your team with meaningful, actionable insights from time to time.  

Secure your business with payroll compliance 

Payroll compliance can not only save your business from financial and legal repercussions but also build a positive brand trusted by your employees and customers.  

At Hobasa, we think of payroll compliance as an ever-changing landscape, navigating which can get complex for your HR and finance teams. By implementing the best practices shared above and harnessing payroll analytics, you can establish a strong compliance system. This will ensure that your payroll processes are aligned with the current laws and regulations and that mistakes are caught at an early stage.  

As business leaders, you need to look at payroll compliance as an ongoing commitment and not a one-time effort. Investing time and resources to build a compliant payroll system today will save your business from legal headaches and financial risks in the future.  

Stay prepared, utilize analytics, and ensure your payroll operations always remain on the right side of the law!