Administering accurate and timely
payroll is one of the most important responsibilities for any employer. Beyond affecting morale and employee
well-being, payroll errors or noncompliance can expose companies to a lot of risk.
When payroll practices don't align with the latest legal policies, it could result in costly penalties, fines, and even legal action. Additionally, payroll mistakes can damage employee trust, lower morale, and disrupt day-to-day operations.
Here’s a guide to payroll compliance to help businesses reduce risk, stay aligned with legal requirements, and maintain strong, positive employer-employee relationships.
What is payroll compliance?
Payroll compliance refers to an employer's responsibility to follow federal, state, and local
employee compensation laws. To remain compliant, employers need to keep detailed and accessible payroll records — including information on employee hours worked and tax filings — in case of audit or regulatory reviews.
Beyond making sure employees receive the correct wages at every
pay period, compliance includes other aspects of payroll processing, such as calculating and withholding funds for income taxes. Other legally mandated deductions, like wage garnishments, count as compliance requirements when applicable.
Why is payroll compliance important?
Maintaining strong payroll compliance practices protects both employees and the business. It not only prevents legal and financial risks but also strengthens trust and credibility within the workforce.
Payroll compliance is important because it:
Ensures fair and timely pay. Employees receive the compensation they’ve earned on schedule, fostering financial stability, fairness, and peace of mind.
Reduces legal and financial risk. Non-compliance puts companies at risk of penalties ranging from legal fees to criminal charges. Inaccuracies or omissions could be costly.
Builds employee trust and satisfaction. Confidence in paycheck accuracy and deductions strengthens the employee-employer relationship and can contribute to higher engagement, improved survey scores, and reduced
turnover.
Upholds brand reputation. Payroll violations can quickly become public knowledge and affect a brand's image. This can be challenging to repair and may weaken existing business partnerships or talent acquisition initiatives.
Examples of payroll laws and regulations
Businesses should regularly review payroll tax compliance laws at the federal, state, and local levels. Although payroll regulations can change from year to year, there are a few standard laws all companies need to understand:
Fair Labor Standards Act (FLSA). For most private and public sector employees, the
FLSA is the foundational federal law for minimum wage, record-keeping requirements, and child labor standards. The FLSA also dictates proper employee classification (
exempt versus non-exempt), which indicates which employees are eligible for overtime and other payroll protections.
Social Security and Medicare. Under Federal Insurance Contributions Act (FICA), employers and employees have to contribute to Social Security and Medicare via payroll deductions and withholding. Although these required rates can fluctuate, the IRS sets
Social Security at 12.4% and Medicare at 2.9% as of 2025.
Federal Unemployment Tax (FUTA). FUTA is a mandatory federal tax on employers to fund unemployment compensation programs, ensuring employees have access to temporary financial assistance if they lose their jobs through no fault of their own.
Equal Pay Act (EPA). An amendment to the FLSA, the
EPA prohibits wage discrimination based on sex. To comply with the EPA, businesses must regularly review their pay practices to ensure equity for employees, regardless of gender.
State and local tax laws. Not all mandatory payroll compliance laws are federal. Businesses also have to navigate state and local income tax laws, unemployment insurance policies, and other specific requirements like paid sick leave mandates, depending on where they operate.
What are payroll deductions?
Calculating the proper deductions is an integral part of what payroll tax is, but not all of these withholdings are legally required. While mandatory deductions such as taxes and social security must always be processed accurately, employers must also account for deductions tied to
employee benefits, which include health insurance premiums, 401(k) contributions, and more.
Here’s a quick guide covering common deductions:
Federal, state, and local income tax. Employers have to withhold income tax from employee wages based on the employee's
W-4 form and where they fit in official
tax tables. These withheld amounts go to relevant tax authorities like the IRS or state tax officials.
Social Security and Medicare (FICA). Like payroll tax compliance laws, FICA taxes are mandatory in payroll processing. They include a deduction from employee pay with a matching contribution from the employer. FICA funds go directly towards Social Security benefits and Medicare insurance.
Unemployment insurance. Both FUTA and the State Unemployment Tax Act (SUTA) are requirements that fund unemployment benefits. Although there are variations between different SUTA requirements, both FUTA and SUTA are employer-paid deductions that provide for employees who recently lost their jobs.
Wage garnishments. Wage garnishments are mandatory, court-ordered deductions from an employee's earnings that pay debts such as child support, alimony, or unpaid taxes. By law, employers must process garnishments accurately and remit funds to the designated entity.
Benefits. Although not a requirement, it's common for employers to offer voluntary benefits like health insurance, and retirement plans like 401(k)s. In some cases, the deductions for employee contributions to these plans happen on a pre-tax basis, which is an extra incentive because it reduces an employee's taxable income.
Payroll compliance checklist: 5 common mistakes to avoid
Even with the best intentions, payroll errors can happen, and the consequences are often costly. Here are a few of the most common payroll mistakes to avoid:
1. Misclassifying employees and contractors
Permanent employees are entitled to protections such as minimum wage, unemployment insurance, and employer-paid payroll taxes, while independent contractors are not. Misclassifying employees as contractors can expose companies to significant legal and financial liabilities, including back taxes, unpaid benefits, and IRS penalties.
To prevent this mistake, employers should use clear guidelines like the
IRS's Common Law Test to determine each worker's status.
2. Missing reporting deadlines
Delays in submitting required tax forms and remitting payments can trigger automatic penalties from the IRS or state-level agencies. Businesses can avoid missing due dates by implementing a compliance calendar or automating reminders through payroll software — this keeps HR and finance teams aligned on deadlines.
3. Incorrect tax withholding
Using outdated employee information or applying incorrect federal, state, or local tax rates can yield errant withholdings. This not only disrupts an employee’s expected take-home pay but may also create unexpected year-end liabilities or refunds. To prevent this, businesses should regularly update employee records, review tax rate changes, and use payroll systems that automatically adopt the latest withholding tables.
4. Misapplying overtime rules
Under the FLSA, non-exempt employees
must receive overtime pay — typically time and a half — for any hours worked over 40 in a workweek. Related mistakes include incorrectly classifying employees as exempt, failing to track hours accurately, or misunderstanding state-specific overtime laws. Besides triggering back pay obligations, misapplying overtime can harm employee trust and company credibility. It’s important to train managers on overtime requirements, use accurate time-tracking tools, and review exemptions regularly to ensure compliance.
5. Not updating payroll systems regularly
Payroll regulations like tax rates and filing requirements frequently change at the federal, state, and local levels. Companies that use outdated software or inefficient manual processes risk missing these changes and submitting erroneous information that prompts penalties and audit requests. Businesses can avoid this issue by updating payroll systems automatically through cloud-based platforms or working with third-party vendors.
Help support employees with financial wellness through EarnIn
Payroll compliance is a cornerstone of the employer-employee relationship. When employees consistently receive their correct pay on time, it can help promote financial stability, build trust, and reflect well on an organization's integrity.
However, even with compliant and consistent payroll processes, personal finances remain
one of the most common stressors for American employees. Companies can ease the strain for employees in and out of the office by offering flexible benefits and actively promoting financial wellness.
That’s where EarnIn comes in. As a no-integration and no-cost financial wellness solution for employers,
EarnIn complements existing payroll systems with tools that help employees build better financial habits. With
Earned Wage Access (EWA), a employees can access their pay – up to $150 per day, with a max of $750 per pay period
– when they need it
Employees can get paid the same day they work using Lightning Speed, starting at $3.99 per transfer,
or use the no-cost option to get their money within 1–3 business days. Tips are always optional.
Additional tools like
Credit Monitoring,
which allows employees to track their credit scores, and
Balance Shield to help avoid the surprise of overdrafts.
Book a demo today to learn how EarnIn’s financial wellness benefit can work alongside payroll to support employees.
Please note, the material collected in this post is for informational purposes only and is not intended to be relied upon as or construed as advice regarding any specific circumstances. Nor is it an endorsement of any organization or services.
This Blog was sponsored by EarnIn. While the author received compensation, the information shared is grounded in independent research and intended to provide helpful and accurate guidance to readers.
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