What Is Payroll Compliance? An Overview of Requirements

Payroll compliance involves a business’s adherence to various laws and regulations governing employee compensation, taxes, and benefits. Proper payroll management helps businesses avoid legal issues, financial penalties, and operational disruptions. This includes federal, state, and local requirements.

Federal Compliance Requirements

Federal laws establish the foundational requirements for payroll operations across the United States. The Fair Labor Standards Act (FLSA) sets standards for minimum wage, overtime pay, record-keeping, and child labor. This law requires employers to pay employees a minimum wage, though many states and localities have higher rates. For hours worked over 40 in a workweek, non-exempt employees receive overtime pay at one and a half times their regular rate. The FLSA also defines “exempt” employees based on salary and job duties.

The Federal Insurance Contributions Act (FICA) mandates contributions for Social Security and Medicare. These taxes are split between employer and employee, with Social Security having an annual wage limit and Medicare having no wage limit. An additional Medicare tax applies to individual wages exceeding a certain threshold.

The Federal Unemployment Tax Act (FUTA) imposes a tax on employers to fund unemployment compensation programs. Employers can receive a credit against this tax if they pay their state unemployment taxes on time.

The Affordable Care Act (ACA) impacts employer-sponsored health coverage and reporting. Applicable Large Employers (ALEs), generally those with 50 or more full-time equivalent employees, must offer affordable health coverage providing minimum value to their full-time employees and their dependents, or face penalties. ALEs are also required to report information about the health coverage they offer to the IRS and to their employees annually using Forms 1095-C and 1094-C.

The Family and Medical Leave Act (FMLA) allows eligible employees of covered employers to take unpaid, job-protected leave for specific family and medical reasons. Reasons include birth or adoption of a child, caring for a spouse, child, or parent with a serious health condition, or an employee’s own serious health condition. Employers must continue to maintain the employee’s group health benefits during FMLA leave. The Department of Labor (DOL) and the Internal Revenue Service (IRS) enforce these laws.

State and Local Compliance Requirements

Payroll compliance extends beyond federal mandates to include state and local laws. Most states require employers to withhold state income tax from employee wages. Employers must then remit these withheld taxes to state tax authorities according to specific payment schedules.

State Unemployment Insurance (SUI) programs require employers to pay state-specific unemployment taxes. SUI tax rates vary significantly by state and are often adjusted annually based on an employer’s “experience rating.” A business with fewer former employees claiming benefits may have a lower SUI rate compared to one with many claims.

Many states have their own wage and hour laws that may be stricter than the FLSA. For instance, state minimum wage laws often exceed the federal minimum wage, and employers must pay the higher rate. States may also have unique rules regarding overtime calculations, daily overtime, mandatory meal and rest breaks, and specific requirements for the timing of final paychecks upon termination. Some states also dictate how frequently employees must be paid, weekly, bi-weekly, or semi-monthly.

Many states and localities have implemented laws mandating paid sick leave, paid family leave, or other types of paid time off. These laws specify how much leave employees can accrue, the reasons for which it can be used, and whether it carries over.

Some cities, counties, or local jurisdictions impose their own income taxes, payroll taxes, or other taxes. Employers operating in these areas must withhold and remit these local taxes. Staying informed about laws in each state and locality is important for compliance.

Payroll Record-Keeping and Reporting

Accurate payroll record-keeping is an important aspect of compliance. Employers must maintain detailed records for each employee, including:

Full name, address, Social Security number, occupation, and date of birth (for those under 19).
Hours worked each day and week.
Regular hourly pay rate, total straight-time and overtime earnings.
Additions to or deductions from wages.
Total wages paid each pay period and the date of payment.

Employers must retain employees’ Form W-4, Employee’s Withholding Certificate. Payroll registers, which summarize gross wages, deductions, and net pay, are also necessary. These records are important for demonstrating compliance during audits.

Employers have various reporting obligations to federal, state, and sometimes local authorities. Federally, these include:

Form 941, Employer’s Quarterly Federal Tax Return, to report withheld income, Social Security, and Medicare taxes (including the employer’s share).
Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, filed annually to report FUTA tax liability.
Form W-2, Wage and Tax Statement, provided annually to employees, detailing wages, tips, other compensation, and withheld taxes.
Form 1099-NEC, Nonemployee Compensation, issued to independent contractors for services.

States also have analogous reporting requirements, including state unemployment and withholding tax reports. New hire reporting is also required by many states. Federal law requires employers to keep payroll records for at least three years, with wage calculation records for two years. Organized record-keeping and timely reporting are important for compliance and avoiding penalties during audits.