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HR departments juggle numerous responsibilities, and payroll compliance ranks among the most complex and high stakes. Mistakes or oversights can trigger many costly consequences, from financial penalties to reputational damage.
Even diligent HR teams can slip up if they’re misinformed or not fully up to date with evolving labor laws and tax regulations. Staying informed and proactive is critical to keeping payroll processes accurate and compliant.
Explore the most common payroll compliance pitfalls and practical strategies to help employers meet their legal obligations.
What is payroll compliance?
Payroll compliance refers to the process of following all applicable local, state, and federal laws when compensating employees or contractors. It involves calculating wages and taxes, and issuing timely payments. Ultimately, responsibility for payroll compliance falls on employers and HR teams, who must ensure the processes meet legal standards and protect the company from potential fines or issues.
At a more detailed level, payroll compliance includes:
- Calculating wages accurately
- Issuing payments on schedule to employees and contractors
- Applying all relevant tax withholdings and deductions
- Withholding Social Security and other mandated contributions
- Filing annual tax forms, such as W-2s and 1099s
Primary payroll compliance requirements and laws
Payroll compliance varies by region and organization, but at its core, it requires adhering to all relevant tax and labor laws. Companies must research their specific obligations, but the following provides a high-level payroll compliance checklist for U.S. operations and considerations for international hiring.
Classification
Worker classification determines whether a person is an employee or an independent contractor, which affects payroll compliance requirements. Employees are entitled to certain benefits and have taxes withheld from their paychecks, while contractors don’t. The paperwork also differs—employees complete W-4 forms and contractors submit W-9s. Correct classification begins during onboarding and continues through payroll and offboarding. Staying compliant at every stage helps avoid legal risks associated with misclassification.
Fair Labor Standards Act
The Fair Labor Standards Act (FLSA) sets rules for minimum wage, child labor, and overtime pay. Companies can only hire minors in unique circumstances, such as agricultural work, with strict hours and wage restrictions. Organizations must pay adults at least the federal minimum wage for standard hours, up to 40 per week, and overtime for hours beyond that. Certain salaried employees earning above specified thresholds may be exempt from overtime or minimum wage protections. Some states enforce stricter laws that override federal standards. The FLSA also outlines recordkeeping requirements, including employee information, working hours, and wages.
Federal Insurance Contributions Act
The Federal Insurance Contributions Act (FICA) defines how much of an employee’s wages a company must withhold for Social Security and Medicare taxes. Contributions support current beneficiaries and help fund future benefits. Employers remit FICA payments to the IRS on a monthly or semiweekly schedule and report them on form 941 (quarterly) or form 944 (annual).
Federal Unemployment Tax Act
Under the Federal Unemployment Tax Act (FUTA) employers pay federal and often state unemployment taxes directly to the IRS. Companies report payments quarterly on form 940. FUTA taxes don’t come out of employee wages—they fund unemployment benefits for eligible workers.
Equal Pay Act
The Equal Pay Act (EPA) prohibits gender-based wage discrimination, ensuring equal pay for equal work. EPA defines comparable work by similar effort, responsibility, skill, and working conditions within the same organization.
Employee fringe benefits
The IRS considers non-wage compensation, like company cars, travel perks, and discounts, part of taxable income for payroll compliance purposes. Employers must report the fair market value of benefits minus any employee contributions. For example, if a company provides a $20,000 car and the employee pays $5,000, the remaining $15,000 should be treated as taxable income.
State law
State labor laws often supersede federal regulations. Minimum wage, overtime, break and meal requirements, and sick leave policies can vary widely, even between counties in the same state. Companies must stay informed of these differences to maintain compliance locally.
International law
Companies hiring internationally must comply with the labor and tax laws of the countries where contractors and employees work. This includes classifications, tax withholdings, and reporting obligations. Partnering with global payroll compliance experts, such as Oyster, can help manage these complexities, reducing risk and alleviating the burden on HR teams.
Common mistakes in payroll compliance
Organizations risk legal action, fines, and reputational damage when they don’t execute payroll processes properly. Strengthen your payroll procedures by avoiding these common pitfalls.
Misclassifications
Accurately classifying employees and contractors is critical to ensure you gather the right documentation, apply benefits appropriately, and handle tax withholding correctly. Understand the factors that define an employee role, such as working under managerial supervision or following a set schedule, to avoid violations.
EPA non-compliance
Maintain a fair and inclusive workplace and mitigate legal risks by following the EPA. Employees can file lawsuits for gender-based pay discrimination, and even unintentional violations can harm a company’s reputation. Regularly auditing pay practices help maintain compliance.
Tax and compensation errors
Paying workers correctly requires careful attention to classification, benefits, and tax withholdings. Mistakes often stem from an incomplete understanding of federal and state regulations. Employers should thoroughly research applicable payroll laws and consider partnering with third-party payroll tax compliance experts, like Oyster, to avoid errors and stay aligned with regulations.
Incomplete records
Maintaining complete records for all hires, including payments and overtime, is vital—inadequate documentation can lead to lawsuits and penalties. Companies should be able to easily provide clear records to demonstrate compliance in case of an investigation.
3 best practices for payroll compliance
Payroll compliance may seem complex, but many organizations successfully follow labor laws and avoid penalties. The key is to implement structured processes and seek expert guidance when needed. Adopting the following payroll best practices helps HR teams maintain accuracy.
1. Use payroll software
A reliable payroll system can safeguard your HR processes and minimize errors. Software securely gathers onboarding documentation, keeps employee records up to date, and accurately calculates wages and tax withholdings. For example, Oyster’s payroll compliance software supports legal hiring and payment across multiple countries, helping organizations stay compliant globally.
2. Create a payroll calendar
Developing a payroll calendar, both internal and employee-facing, is a key step in maintaining compliance. Internal calendars align HR and finance teams around critical deadlines, such as paydays and tax filing dates. Employee-facing calendars clarify expectations for timesheet submissions and payment schedules, improving transparency and improving the overall worker experience.
3. Stay on top of IRS due dates
Timely payroll extends beyond issuing timely paychecks—it also requires meeting IRS deadlines. Companies must track when FUTA and FICA taxes are due and ensure all required quarterly or annual filings are submitted accurately. Staying organized with due dates helps prevent costly penalties and maintains regulatory compliance.
Stay compliant with Oyster
Protect your company from costly lawsuits, penalties, and IRS complications by staying fully compliant, no matter where your workers are. If you hire internationally, partner with leading EOR and global payroll compliance platform Oyster.
Oyster ensures seamless, accurate payments to employees and contractors in more than 180 countries and handles local tax and regulatory requirements, reducing the burden on your HR team. Your workforce will enjoy timely payments, while you maintain peace of mind knowing your organization is fully compliant.
Explore Oyster today to learn how it can simplify global payroll compliance.
About Oyster
Oyster is a global employment platform designed to enable visionary HR leaders to find, engage, pay, manage, develop, and take care of a thriving distributed workforce. Oyster lets growing companies give valued international team members the experience they deserve, without the usual headaches and expense.
Oyster enables hiring anywhere in the world—with reliable, compliant payroll, and great local benefits and perks.
