Payroll Compliance Checklist and Tax Law Guide for 2023
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Running payroll requires more than paying your employees. Whether you’re a small business owner or a payroll manager for a large corporation, a payroll compliance checklist can help you understand and comply with payroll requirements wherever your employees live.
In this article, you'll learn the essential payroll compliance requirements to avoid the risk of non-compliance under US federal and state laws.
Disclaimer: This content is for informational purposes only and is not intended as tax or legal advice.
What is payroll compliance?
Payroll compliance is adhering to all government regulations about how employers must pay their employees. Employers must adhere to federal, state, and local payroll laws for each employee, and failing to do so can lead to IRS penalties and fines.
Payroll compliance checklist for 2023
While state and local regulations will vary from place to place, you can expect to deal with similar laws wherever you hire employees. Most payroll compliance laws cover:
- Worker classification: Employees and independent contractors fit the correct classification criteria
- Worker eligibility: Employees are legally eligible to work in the US (if applicable)
- Tax withholding and reporting: You have withheld and reported the correct taxes for employees, as per their local laws and Form W-4—a US tax document that employees fill out to let their employer know the correct amount of money to withhold from their salary for federal taxes
- Payments: You have paid employees correctly and on time, following their local government payroll regulations
- Wages and hours: Your employees are earning minimum wage and are meeting the mandated work hour requirements
- Wage withholding: You have withheld the correct amounts of wages from employees’ pay for child support and garnishments
- Depositing funds: You have deposited the necessary funds to the correct government agencies
- Filing taxes: You have filed the correct tax forms to government agencies
Payroll and tax compliance (federal government)
Federal payroll tax compliance includes the tax-related payroll compliance mandated at the national level. You’ll have to adhere to five federal payroll tax compliance laws if you have employees working in the US.
Fair Labor Standards Act (FLSA)
The Fair Labor Standards Act (FLSA) outlines wages and overtime pay standards. FLSA is regulated by the Wage and Hour Division of the Department of Labor (DOL). The Act establishes the federal minimum wage as $7.25 (USD) per hour and overtime rates at no less than one and one-half times the regular pay rate after 40 hours in a workweek.
The FLSA stipulates that the employee is entitled to a higher pay rate if the state/local and federal minimum wages are different. FLSA also regulates:
- What counts as hours worked
- How employers execute record keeping for time and pay
- Child labor provisions to protect minors’ educational opportunities
Learn more about the FLSA.
Federal Insurance Contributions Act (FICA taxes)
The Federal Insurance Contributions Act (FICA) requires employers to withhold a percentage of an employee’s paycheck for Social Security and Medicare taxes. The IRS regulates FICA taxes.
Social Security taxes collect funds for old-age, survivors, and disability insurance taxes. Currently, the tax rate for Social Security is 12.4%, with 6.2% taken from employee earnings and the other half from employer contributions. The Social Security tax has a wage base limit. In 2023, the maximum wage base will be $160,200.
Medicare taxes, also known as the hospital insurance tax, are currently set at 2.9%, with each employee and employer paying 1.45%. There is no wage base limit for Medicare tax.
Learn more about FICA taxes.
Federal Unemployment Tax Act (FUTA taxes)
The Federal Unemployment Tax Act (FUTA) requires governments to provide unemployment compensation payments to workers who have lost a job. Most employers must pay both federal and state FUTA taxes, and these fees aren’t deducted from the employees’ wages.
Employers must pay 6% of each employee’s first $7,000 of annual earnings. If your business is in a state that also requires unemployment taxes, you may be eligible for a credit that would lower your federal FUTA tax rate to 0.6%.
Learn more about FUTA rules and taxes.
Equal Pay Act (EPA)
The Equal Pay Act (EPA) is an amendment of the FLSA that protects against wage discrimination based on gender. The EPA guarantees that employers offer equal pay for equal work and covers all forms of compensation, including:
- Overtime pay
- Life insurance
- Holiday pay
- Cleaning or gas allowances
- Hotel accommodations
- Reimbursements for travel expenses
If a business demonstrates a wage gap between men and women performing equal work, the employer must raise the wages to equalize pay. They cannot reduce anyone’s wages.
Learn more about the EPA.
The Davis-Bacon and Related Acts apply to contractors and subcontractors working on federally funded or assisted contracts for public works or building projects over $2,000. Under the Davis Bacon Act, contracting business owners must submit Form WH-347 (certified payroll) to demonstrate they pay laborers and mechanics at least the locally prevailing wages and fringe benefits.
Learn more about the Davis Bacon and Related Acts.
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Payroll compliance (state law)
In the US, each state has additional laws regarding payroll compliance. The state laws may conflict or stack on top of the federal laws—you always need to meet the minimum for both.
Let’s take a look at some of the topics covered in state payroll compliance laws.
Many states have their own minimum wage laws. Since the state laws have to meet the $7.25 per hour federal minimum, most state minimum wages exceed the federal minimum wage. In these instances, employers must meet the higher state minimum wage.
In some cases, municipal governments will have their own tax laws that differ from the state regulations. For example, as of December 31, 2022, the New York state minimum wage is $14.20, while the minimum wage in New York City (NYC), Long Island, and Westchester County is $15. Therefore, employers operating out of NYC have to follow the $15 per hour rate.
See the current minimum wage in each state.
Under federal laws, employers must give their non-exempt employees overtime pay for any hours over 40 hours in a given workweek. Some states have more intricate stipulations for employee overtime pay.
Some states require employees to pay the overtime rate if a non-exempt employee exceeds a daily limit (8, 10, or 12 hours). California even requires employers to pay double-time wages in specific scenarios.
Learn more about state-specific overtime laws.
Some states have laws regarding how employers pay their employees (i.e., direct deposit or paper checks). Some states don’t allow you to pay employees through direct deposit or pay cards unless you meet specific requirements outlined in the state’s laws.
Many states will stipulate that to utilize direct deposit or pay cards, you must:
- Ask employees for permission
- Offer additional payment methods like paper checks for people who don’t want to enroll in the other options
- Cover accompanying fees
- Notify employees of fees associated with using alternative payment methods
Learn more about state-specific payment method regulations.
Pay period frequency
Some states have laws regulating pay period frequency or how often you pay employees. Certain states also have different stipulations for different industries or professions.
Paid sick leave
At the time of publication, the following states have state laws on paid sick leave:
- District of Columbia
- New Jersey
- New York
- Rhode Island
Some states have further local laws regarding sick leave requirements, usually on the municipal level. Learn more about state-specific paid sick leave.
Paid Family leave
At the time of publication, the following states have state laws regarding family leave:
- District of Columbia
- New Jersey
- New York
- Rhode Island
Learn more about creating fair, compliant parental leave policies.
Most states have laws mandating employers to provide employees with their final paycheck once they leave a business within a certain number of days. Some states will have different stipulations based on whether the employee quit or was fired.
Browse final paycheck compliance requirements by state on the DOL website.
Paid time off (PTO) payout
Some states require employers to pay employees for earned but unused PTO at year-end or when they leave the company. Even if your state doesn’t require you to offer PTO, they may still have a PTO payout law. Note: This applies to employees, not PTO for independent contractors.
Explore PTO payouts by state.
Most states require employers to purchase workers’ compensation insurance. Exemptions to state workers’ compensation laws are rare, and Texas is the only state that allows employers to opt out of workers’ comp.
See the state-by-state requirements for workers’ compensation.
Global payroll compliance
If your business operates on a global scale, you’ll also need to adhere to international payroll processing regulations. Specifically, you’ll have to comply with laws wherever each employee lives, not where your business is located.
Some of the various international payroll laws that may impact global payroll include:
- European Union Working Time Directive (WTD): The EU’s regulations for member nations limiting the number of hours an individual can work each week, including overtime
- Labor Law of the People’s Republic of China: China’s laws stipulating daily and weekly hour limits, wages, and guidelines on employee contracts, labor disputes, working conditions, welfare, and overtime
- Wages Protection System of the United Arab Emirates (UAE): The UAE’s guidelines for registering with the Ministry of Human Resources and Emiratisation and paying employees through an approved financial institution by established deadlines
- UK Employment Rights Act: The United Kingdom’s law regulating employment contracts, dismissal notices, unfair dismissal, parental leave, and redundancy
- Labor Standards Act of Japan: Japan’s laws for minimum wage, working hours, overtime, annual leave, and other payroll guidelines
- German Act on Part-Time Work and Fixed-Term Contracts: Germany’s guidelines for increasing or decreasing hours for fixed-term workers
Non-compliance: Common mistakes and penalties
Non-compliance and subsequent penalties are steep. You want to avoid unnecessary mistakes that will take away from your bottom line, especially if you’re a small business owner.
Misclassifying employees as independent contractors
Employee classification is essential when generating contracts for new hires during onboarding. Worker classification determines the employer’s responsibilities for state and federal income tax withholding and tax filing processes at the end of the year. The IRS’s Withholding Compliance Program may review employees’ former Form W-2s to ensure their taxes have been correctly withheld.
Misclassifying an employee can have serious consequences. Failing to comply with worker classification regulations can lead to:
- Tax violation fines of up to 3% of the misclassified employee’s wages, 100% of the FICA taxes that were unpaid, up to 40% of the FICA taxes that weren’t withheld, and $50 for every IRS Form W-2 you didn’t file for the misclassified employee
- Federal law violation fines of up to $1,000 per misclassified employee plus legal fees and repayments
- Jail time of up to one year
Failure to keep payroll records
Many compliance issues arise because of poor recordkeeping. Depending on the record in question, you’ll need to keep payroll records for at least two to four years. For safety, many businesses will keep all payroll records for at least six years.
The most significant penalty associated with not keeping records as long as necessary is the risk that your business will get audited, and you’ll have no way of proving that you complied with the law. Companies have lost legal battles because they didn’t keep their records long enough.
Failure to provide adequate workers’ compensation
Your state legislation may flag you for non-compliance with workers’ compensation laws for failure to file or accurately complete forms, pay benefits in a timely fashion, or pay the proper amount owed to the employee.
The severity of the punishment for failing to purchase workers’ compensation insurance varies based on the state, but the penalty is typically a fee.
Failure to track and pay overtime
Even though it could be a simple human error, not tracking employees’ overtime and fringe benefits can lead to sticky situations down the road if an employee feels like they were cheated on their pay. The best thing you can do to avoid unnecessary mishaps is to rethink how you run payroll.
Failure to pay payroll taxes on time
When should payroll taxes be paid? Employers must withhold payroll taxes when paying their employees every tax year. Usually, the tax is withheld from their regular paycheck and delivered to the relevant authorities monthly or biweekly.
Tips for managing payroll tax compliance
Payroll best practices are constantly evolving. The good news is that you don’t have to manage payroll alone. Modern times offer modern solutions, so you have a few options for navigating payroll and payroll compliance.
Use a payroll software
Instead of relying on employees to crunch the numbers themselves, adopt an automated payroll software or centralized payroll system to save time and avoid errors. Payroll software is less time-intensive than spreadsheets and helps reduce human error (and subsequent non-compliance) regarding employee hours, wage calculations, and payroll records.
Outsource to a payroll service provider
If you’re running a small business and can’t afford to have a full-time payroll manager on staff, outsourcing to a payroll provider may be your best bet. A payroll service provider can take care of payments, payroll tax management, paperwork, and compliance so you can focus on the other aspects of running your business.
Access resources to expand your payroll compliance knowledge
At Deel, we’ve created several templates, guides, and payroll policies you can use to round out your payroll compliance knowledge:
- Global Payroll Template
- Guide to Global Payroll
- The Remote Team’s Guide to Employee Compensation Strategies
Never worry about compliance again with Deel
Deel’s global payroll solution helps you stay compliant and eliminate ongoing payroll admin duties with fully managed payroll.
We take care of government declarations, taxes, compliance, calculations, and more. You just need someone to update any changes or adjustments like new employees, a termination, or promotions and raises.
Learn more about Deel’s Global Payroll today.