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Payroll Compliance: A Complete Guide and Checklist

Key Takeaways

1. If you are employing staff in the United States, you must ensure that the appropriate payroll deductions are made and filed with the IRS in accordance with legislation.

2. Payroll compliance starts with the correct classification of workers because this dictates whether the employer withholds any tax from the worker’s wages or not.

3. There are several laws governing payroll compliance in the USA at the federal, state, and local level, including the Fair Labor Standards Act (FLSA) and the Federal Insurance Contributions Acts (FICA).

4. Payroll compliance legislation is important because the various underpinning laws ensure that employees are paid equitably and treated fairly.

If you are employing staff in the United States, you must ensure that the appropriate payroll deductions are made and filed with the IRS in accordance with legislation. 

Employers who offer an enhanced HR package, (including items like fringe benefits, stock options and cryptocurrency payments), will experience a more onerous payroll compliance regime.

This is particularly the case with cryptocurrency payments, which are increasingly being used to compensate employees. Industry experts commenting on Bloomberg welcome this innovative method of compensation but warn employers to make themselves aware of the ‘logistical and compliance related concerns before diving in’. Factors to consider are the experimental nature of crypto payroll data and the huge volatility around digital currencies.

What is payroll compliance?

Payroll compliance is one part of HR compliance. When delivering payroll, you must follow the payroll requirements as stipulated by both federal and state law. These compliance procedures relate to the withholding of a range of different taxes from your employee’s paycheck. Federal income tax is the most recognizable tax withholding. Compliance also requires reliable processing of payroll data which is best achieved by applying payroll performance indicators.

The key compliance requirements for payroll

Payroll compliance starts with the correct classification of workers because this dictates whether the employer withholds any tax from the worker’s wages or not.

Workers who decide when and how their work is done are generally considered to be independent contractors and pay their own income taxes and self-employment tax. This means that employers are not required to deduct tax from their earnings.

If a worker is told when and how to do the work – with more limited self-control – the worker is deemed to be an employee and payroll taxes should be withheld.

In practice, this distinction between employee and independent contractor is not always clear and employers frequently misclassify employees which leads to fines and levies from the IRS and employers may have to reimburse back taxes or unpaid overtime wages. Employers who are unsure about a worker’s classification can have this confirmed one way or another by submitting Form SS-8 to the IRS.

Significant payroll compliance laws

There are several laws governing payroll compliance in the USA at the federal, state, and local level. Below, are some of the most prominent ones:

  • Fair Labor Standards Act (FLSA)
  • Federal Insurance Contributions Acts (FICA) (read more about this below)
  • Federal Unemployment Tax Act (FUTA)
  • Davis-Bacon Act
  • Equal Pay Act

Video: Meet the experts — payroll compliance practitioners (PCPs)

Those who specialize in payroll compliance can earn certification as a payroll compliance practitioner. Learn more about the role here. 

Which deductions does payroll compliance require?

Payroll compliance in the US requires that employers deduct specified amounts from an employee’s salary. The amount that an employer withholds for each employee is determined by several factors including their Form W-4 Employee’s Withholding Certificate, relevant state and local withholding certificates, choice of benefits and more. Key taxes include: 

  • Income tax
  • There are several federal income tax brackets: 10%, 12%, 22%, 24%, 32%, 35% and 37%, which are applied progressively to employees depending on how much they earn. For example, this year the first $9,950 of earnings is taxed at 10%, earnings between $9,950 and $40,520 are taxed at 12% and so on. You can find a comprehensive table of income tax brackets here. An employees’ tax bracket is also affected by their filing status of which there are four: single, married, head of household, and married filing jointly, and these are specified on the Form-W4. Income tax brackets are typically adjusted annually in line with inflationary pressures.
  • State income legislation can vary widely with some charging a fixed rate against all income, while others have several tax brackets and 9 states charge no income tax at all.
  • Social security tax
  • FICA (Federal Insurance Contributions Act) is a US federal payroll tax and is deducted from each paycheck by the employer. A 6.2% deduction goes towards social security tax and additional 1.45% deduction goes towards Medicare tax. The employer is required to match these contributions for a total of 15.3%. FICA helps to fund the social security and Medicare programs which provide benefits for retirees, the disabled and children.
  • Wage garnishments
  • This is a legal procedure where some or all an employee’s earnings are, (due to a court order or IRS instruction) withheld by an employer for the payment of a debt such as child support.

Which payroll deductions are voluntary?

Employees may elect to have money withheld from their paycheck to cover the cost of benefits. These are termed ‘voluntary deductions’ and since they are optional, employers should ensure that employees are aware of them. It is recommended that the employee’s written consent be gained before making the deduction and the current monthly deduction and accumulative total for the year should be displayed on every pay statement. There are several kinds of voluntary deduction and two of the most common are:

  • 401(k) contributions
  • 401(k) is a type of retirement plan to which employees can elect to contribute a portion of their wages to a personal retirement account. Elective salary deferrals are excluded/deferred from the employee’s taxable income until distribution on retirement. Employers can contribute to employees’ accounts.
  • Health Insurance
  • The most cost-effective way to deliver this benefit is for the employee and employer to pay insurance premiums on a pre-tax basis by making the contributions through a section 125 plan.

What is payroll tax compliance?

There is no internationally consistent definition of ‘payroll tax’ (sometimes called ’employer payroll tax’). At least four definitions may apply, depending on where you are. We will be focusing on the US definition of payroll tax but if you wish to learn about international interpretations of payroll tax compliance follow the link.

In the United States, ‘payroll tax’ is a technical term, which refers specifically to federal social security (under the Federal Insurance Contributions Act, or ‘FICA’) and Medicare taxes. Part of this payroll tax is withheld from the employee’s gross salary or wages by the employer, while the other component is paid directly by the employer as a ‘matching amount’.

In addition to federal payroll taxes, US employers are responsible for federal income tax withholding and the payment of federal unemployment insurance tax. Furthermore, employers are often required to withhold state and local taxes, which may include state income tax, state disability insurance tax, and school district taxes.

The collective term for all taxes withheld by employers in the United States and submitted to tax authorities is ‘Employment taxes’.

Our payroll compliance checklist

We realize there is a lot to take in and we have therefore summarized this information into a payroll compliance checklist:

  • Determine classification (e.g., employee or not)
  • Complete I-9 and W-4
  • Add employee to payroll system (and assign a payroll ID number)
  • Set up payment method
  • Set up essential deductions
  • Report essential information to the tax department/department of labor
  • Report as required to the tax authorities
  • Regularly audit compliance.

Horizons — the global payroll compliance experts

Payroll compliance covers some of the most important regulatory and legal obligations placed on businesses. The importance of employees being paid correctly means that regulatory authorities are quick to clamp down on anyone who is in breach. 

While we have expertise in US payroll compliance, here at Horizons, we have global payroll expertise and can ensure payroll compliance in any country in the world.

Frequently Asked Questions (FAQ)

When delivering payroll for your organization you must follow the payroll requirements as stipulated by both federal and state law. Each time you run payroll there are intricate IRS-determined procedures to be followed related to the withholding of a range of different taxes from your employee’s check — this is what it means to be payroll compliant. 

Payroll compliance legislation is important because the various underpinning laws ensure that employees are paid equitably and treated fairly. It also ensures that the government has the funds to support important social security programs like Medicare, retirement, disability benefits, survivors, and children.

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