Payroll Compliance Guide 2025

What Is Payroll Compliance?

Payroll compliance refers to the adherence to all laws and regulations governing how employees are paid.

This includes ensuring accurate calculation of wages, timely payment, proper withholding and payment of payroll taxes, and maintaining correct employee records.

Compliance also involves following rules about minimum wage, overtime, benefits, and deductions specific to each jurisdiction where the company operates. 

The goal is to ensure the fair treatment of employees and avoid legal issues, fines, and penalties.

Risks Of Payroll Noncompliance

The risks of payroll noncompliance can be significant and impact both the employer and employees.

Here are some key risks associated with failing to adhere to payroll regulations:

1. Financial penalties: Employers can face substantial fines and penalties for errors in payroll calculations, late tax filings, or failure to make the correct deductions. These fines can accumulate and become financially burdensome, especially for small businesses.
2. Legal consequences: Noncompliance can lead to lawsuits or legal actions from employees, labor unions, or government agencies. Legal disputes can be costly, time-consuming, and damaging to a company's reputation.
3. Reputational damage: Failure to comply with payroll regulations can harm an organization’s reputation. Negative publicity can affect customer trust and employee morale, potentially leading to difficulties in hiring and retaining skilled workers.
4. Operational disruptions: Addressing issues related to payroll non-compliance often requires significant managerial and financial resources, which can distract from regular business operations and impact overall productivity.
5. Employee dissatisfaction: Inaccurate payroll processing can lead to employee dissatisfaction and potentially impact morale and turnover.
6. Audit risks: Companies that do not comply with payroll laws are more likely to be audited by government agencies, which no one enjoys.

Maintaining payroll compliance is fundamental to smooth business operations. Use this checklist to execute payroll accurately.

Who Is Responsible For Payroll Compliance?

Responsibility for payroll compliance typically falls on several key roles within an organization:

1. Owner: Ultimately, the business owner or the employing organization holds the primary responsibility for ensuring payroll compliance. This includes adhering to all relevant laws and regulations related to employee compensation.
2. Payroll department: In organizations with a designated payroll department, these professionals handle the specific tasks involved in payroll processing, such as calculating pay and deductions, filing taxes, and ensuring timely and accurate payments to employees.
3. HR Department: HR often collaborates with the payroll department to ensure compliance, particularly in areas overlapping with employee benefits, new hire reporting, and maintaining up-to-date employee records.
4. Finance department: The finance team often works closely with payroll to manage the budgetary aspects, ensuring funds are properly allocated for salaries, benefits, taxes, and other payroll-related expenses.
5. External payroll service providers: Many companies value the benefits of outsourcing their payroll functions to specialized firms. While external payroll service providers manage the payroll processing, the employer remains responsible for the compliance and accuracy of payroll.
6. Legal and compliance officers: In larger companies, there may be dedicated personnel or departments responsible for monitoring compliance with all legal requirements, including those related to payroll/global payroll.

Each of these roles plays a critical part in maintaining payroll compliance, ensuring that all legal obligations are met, and that employees are paid accurately and on time.

To ensure simple payroll compliance, a no-cost payroll solution can help businesses stay on track without financial strain.

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2025 Payroll Laws And Regulations

The following laws and regulations govern payroll compliance in 2025 (United States).

1. Fair Labor Standards Act (FLSA): Establishes standards for minimum wage, overtime pay, recordkeeping, and youth employment. This act is crucial for determining how employees are compensated for standard and overtime hours.
2. Internal Revenue Code (IRC): Administered by the Internal Revenue Service (IRS), the IRC outlines the rules for withholding and remitting federal income tax, Social Security, and Medicare taxes.
3. Federal Insurance Contributions Act (FICA): Requires employers to withhold Social Security and Medicare taxes from employees' wages and to pay an employer's portion of these taxes.
4. Family and Medical Leave Act (FMLA): Provides eligible employees with unpaid, job-protected leave for specified family and medical reasons. Employers must maintain health benefits during leave as if employees continue to work.
5. Equal Pay Act: Requires that men and women in the same workplace be given equal pay for equal work. The jobs need not be identical, but they must be substantially equal.
6. Immigration Reform and Control Act (IRCA): Mandates employers to confirm an employee's eligibility to work in the U.S. through the I-9 form.
7. Employee Retirement Income Security Act (ERISA): Set minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in these plans.
8. Unemployment Tax Act (FUTA): Requires employers to pay unemployment taxes, which fund the state workforce agencies.
9. State Unemployment Tax Act (SUTA): This act requires employers to pay a state unemployment tax. The specifics of SUTA, including the tax rate, taxable wage base, and the procedures for filing and payment, vary from state to state.
10. Health Insurance Portability and Accountability Act (HIPAA): Among other things, regulates the privacy and security of employee health information, which can be relevant to employer-provided health benefits.

For those operating abroad, take a read of our article on international workforce laws.

Tip: For complete payroll compliance, use pay equity software to ensure consistent compensation practices, address pay gaps, and meet legal and regulatory requirements.

Employee Payroll Classifications

Employee payroll classifications primarily distinguish how employees are paid and which employment laws apply to them. The main classifications include:

Exempt employees

These employees are "exempt" from the overtime provisions of the Fair Labor Standards Act (FLSA). 

They do not receive overtime pay regardless of how many hours they work beyond the standard 40-hour workweek. 

Exempt employees typically perform job duties that are executive, professional, or managerial in nature and are paid on a salary basis at not less than a specified minimum amount.

Non-exempt employees

Non-exempt employees are entitled to overtime pay under the FLSA. They must be paid at least the federal minimum wage for all hours worked and receive overtime pay at a rate of one and one-half times their regular rate of pay for all hours worked over 40 in a workweek. 

This classification covers most hourly workers, but salaried employees can also be non-exempt if they do not meet the criteria for exemption.

Independent contractors

Unlike employees, independent contractors are self-employed and do not receive wages or salaries. 

They typically provide services under a contract for a specified result and are not subject to the same tax withholding or labor law protections (such as minimum wage and overtime) as employees. 

Employers must be careful not to misclassify employees as independent contractors as this can lead to legal penalties.

If you choose to work with independent contractors based in the US, note that you must submit IRS Form 1096 and IRS Form 1099-NEC to summarize and report their earnings, respectively.

Temporary or seasonal employees

These employees are hired for a specific duration or for a specific project, often through a staffing agency. They might be classified as either exempt or non-exempt, depending on their specific job duties and compensation.

Part-time employees

Employees who work fewer hours than a full-time schedule, typically less than 35 hours a week. They can be either exempt or non-exempt based on their salary and job duties. Part-time employees often receive fewer benefits than full-time employees.

Payroll Compliance Deductions

In the USA, payroll compliance involves several mandatory deductions from employees' paychecks. These deductions are generally required by law and must be accurately handled by employers. 

Here are the primary types of payroll compliance deductions:

1. Federal Income Tax: Employers must withhold federal income tax from employees’ wages based on the information provided by employees on their Form W-4. The amount withheld depends on earnings, marital status, and the number of allowances claimed.
2. State and Local Income Tax: Depending on the state and sometimes the local jurisdiction, employers may also need to withhold state and/or local income taxes. The specifics vary widely from one location to another.
3. Social Security Tax: Under the Federal Insurance Contributions Act (FICA), employers are required to withhold a set percentage of an employee’s wages for Social Security taxes, up to a certain wage limit. Employers also match this contribution.
4. Medicare Tax: Also under FICA, a Medicare tax is withheld from employees’ earnings. Like Social Security tax, this is matched by the employer. Additionally, higher earners may be subject to an Additional Medicare Tax.
5. State Unemployment Tax (SUTA): Employers pay state unemployment taxes, which do not typically come out of employees' wages but are a payroll-related tax that employers must manage.
6. Federal Unemployment Tax (FUTA): This is an employer-paid tax, meaning it is not deducted from employees’ wages but is related to payroll compliance.
7. Garnishments: If an employee has a legal judgment against them (such as for child support, alimony, or debt collections), the employer might be required to deduct a portion of their earnings to satisfy the payroll garnishment.
8. Other deductions: Depending on the employer and the employee benefits offered, there may be deductions for retirement plans (like 401(k) contributions), health insurance premiums, life insurance, and other employee benefits. Some of these contributions might be pre-tax (reducing taxable income), while others might be post-tax.

Common Payroll Compliance Mistakes

Payroll compliance can be complex and challenging, with several pitfalls that employers might encounter. 

Here are some common payroll compliance mistakes that businesses often make:

1. Misclassification of Employees: Incorrectly classifying workers as independent contractors instead of employees, or misclassifying non-exempt employees as exempt from overtime and minimum wage laws, is a common error. This can lead to underpayment of taxes and denial of benefits to which employees are entitled.
2. Failure to Pay Overtime: Not paying non-exempt employees overtime at one and one-half times their regular rate for hours worked over 40 in a workweek. This mistake can occur due to poor timekeeping practices or misunderstanding of what constitutes "overtime."
3. Inaccurate Payroll Records: Keeping inaccurate or incomplete payroll records is another common issue. This can make it difficult to prove compliance with labor standards and tax requirements if audited.
4. Errors in Tax Withholdings: Incorrectly calculating the amount of taxes to withhold can result in employees either owing a significant amount at tax time or the employer facing penalties for under-withholding.
5. Late Payroll Tax Deposits and Filings: Failing to deposit withheld income and payroll taxes on time, or filing late payroll tax reports, can result in penalties and interest from the IRS or other tax authorities.
6. Inadequate Record of Hours Worked: Not properly tracking hours worked, especially for hourly and non-exempt employees, can lead to errors in pay and violations of labor laws.
7. Improper Handling of Garnishments: Failing to properly process garnishments such as child support or creditor garnishments can result in non-compliance with court orders and legal complications.
8. Failure to Maintain Updated Compliance with Laws: Payroll laws and regulations can change frequently. Failure to stay updated with the latest rules and regulations (like minimum wage increases or tax rate changes) can lead to compliance issues.
9. Ignoring State and Local Tax Requirements: Employers sometimes overlook state and local tax requirements, which can differ significantly from federal rules. This oversight can lead to unexpected tax liabilities and penalties.
10. Failure to Comply with Niche Payroll Requirements: Many industries have specific payroll compliance requirements, such as certified payroll within the U.S. construction sector. This is a specific type of weekly salary report that applies to any contractor or subcontractor working on a federally financed construction project costing above $2,000.
11. Not Providing Final Paychecks in a Timely Manner: Various states have laws that require employers to provide final paychecks to terminated employees within a certain timeframe. Failure to comply can result in penalties.

Best Practices To Ensure Payroll Compliance

Ensuring payroll compliance is a team effort. Here are some best practices to help ensure payroll compliance:

1. Stay Informed About Changes in Legislation: Subscribe to newsletters and read sites such as SHRM, IRS, Department of Labor, and American Payroll Association to stay updated on any changes to of federal, state, and local payroll-related laws and regulations. This includes staying aware of changes in tax rates, minimum wage laws, and other legal requirements that could affect payroll.
2. Use Reliable Payroll Software: Invest in robust payroll software that can help manage calculations, withholdings, and submissions. The best payroll software will also update regularly to reflect changes in legislation.
3. Maintain Accurate Employee Records: HR and payroll teams are tasked with keeping detailed and accurate payroll registers for employees, including their classification, hours worked, wages paid, benefits, and deductions.
4. Classify Employees Correctly: Understand the differences between independent contractors and employees, as well as exempt and non-exempt status, to ensure appropriate benefits and compliance with wage and hour laws.
5. Regular Training and Education: Provide training for anyone involved in the payroll process on applicable laws and best practices. This helps reduce errors due to misunderstanding or lack of knowledge.
6. Implement Strict Procedures for Timekeeping: Use an efficient and reliable time-tracking system to track employees’ working hours, especially for non-exempt employees. Ensure that employees and managers are aware and trained on the importance of accurate time recording.
7. Review and Audit Payroll Regularly: Regularly review payroll processes and have internal or external audits to catch and correct errors before they become compliance issues.
8. Ensure Secure Data Practices: Protect payroll data through secure systems and protocols to prevent unauthorized access and ensure data integrity. Compliance with privacy laws is also critical.
9. Consult with Payroll Professionals: If necessary, consult with payroll specialists or legal advisors to help navigate complex payroll legislation and ensure compliance.
10. Establish Clear Payroll Policies: Document and communicate clear payroll policies regarding pay periods, overtime, corrections, and other aspects of payroll that might affect compliance.
11. Be Timely with Payroll Taxes and Filings: Ensure that all payroll taxes are withheld correctly and that deposits and filings are made on time to avoid penalties and interest.