Payroll Compliance Checklist for Small Businesses

You can scale your small business by hiring employees to manage day-to-day operations while you grow your business. However, as your team grows, so will your payroll burden. A payroll compliance checklist can help your business stay compliant. 

Why is a payroll checklist important?

A thorough payroll compliance checklist (like the one covered in this article) can help your business comply with employment laws and regulations. After learning about payroll reporting requirements, you can determine whether outsourcing your compliance to payroll tax specialists makes sense for your business.

What is Payroll Tax Compliance?

Payroll compliance refers to recording, paying, and reporting employee wages. Proper payroll compliance is critical to a smooth human resources (HR) function. 

As a small business owner, you’re responsible for capturing your employees’ hours and paying workers timely. Employers must follow federal, state, and local payroll tax reporting rules. 

Payroll Compliance Checklist

1. Correct IRS Employee Classification

Employees and independent contractors create differing reporting and withholding requirements for employers. Determine whether your workers are employees or independent contractors so you can correctly withhold and report your employee payroll taxes. 

If you inadvertently classify an employee as an independent contractor, your business could incur additional taxes and penalties on the employee’s pay. 

The differentiation generally depends on the nature of the employment relationship and the level of control your company has over the worker. The IRS published an employee vs. independent contractor guide to help businesses classify workers. 

The following characteristics generally suggest an employer-employee relationship:

• The business determines the work schedule and location.
  
• The business pays for necessary supplies and equipment.
  
• The employer determines the pay schedule and payment method.
  
• The employment relationship is ongoing, not project-specific.

• Workers receive benefits such as insurance and paid time off (PTO).

If you’re unsure whether your worker is an employee, consider partnering with payroll tax professionals who can help you determine the correct classification.  

2. Compliance with Wage and Labor Laws

Your business must comply with federal, state, and local laws governing employee wage standards. The Fair Labor Standards Act (FLSA) is a federal law governing labor rules such as overtime pay, child labor, and recordkeeping requirements. 

The FLSA requires employers to pay overtime wages to hourly employees who work more than 40 hours during a 7-day consecutive period. Overtime pay must be at least 1.5 times the employee’s regular hourly wage. 

Refer to the FLSA fact sheets and industry-specific guidance to ensure you fairly pay your employees.

Minimum Wage Requirements

The federal minimum wage has been $7.25 per hour since 2009; however, many states have established higher minimum wage requirements. For example, California’s 2024 hourly minimum wage is $16. California businesses must meet the state minimum. 

Further, cities and counties can establish wage requirements above their state minimums. For example, the 2024 New York state hourly minimum wage is $15, but New York City employers must pay at least $16 per hour. 

3. Proper Payroll Tax Withholding

U.S. employees must pay taxes on their wages. Payroll taxes generally include the following: 

• Federal income tax
  
• State income tax
  
• Social Security and Medicare taxes 
  
• Federal Unemployment Tax 

Employers must calculate and withhold the correct tax on employee wages. Your business should keep detailed payroll records so you can file accurate monthly, quarterly, and annual reports. 

Federal and State Income Taxes

The IRS establishes annual income tax brackets, which specify the tax rates applicable to each taxpayer’s income. 

During new hire onboarding, each new employee should complete an IRS Form W-4, Employee’s Withholding Certificate. Form W-4 helps employers determine how much federal income tax to withhold from each employee’s paycheck. 

Most states impose individual income taxes. Check your state and local rules to determine the state income tax rate applicable to your employees. 

Social Security and Medicare Taxes

Under the Federal Insurance Contributions Act (FICA), most U.S. taxpayers must pay Social Security and Medicare Taxes. 

Employees pay a 6.2% Social Security tax on wages up to $168,600 (2024) and a 1.45% Medicare tax. Employers pay an equal share, totaling 12.4% Social Security and 2.9% Medicare taxes. Additionally, employees earning over $200,000 in 2024 must pay 0.9% of additional Medicare tax. Employers do not share the additional Medicare tax burden.

Your business must withhold all applicable FICA taxes from employee paychecks and regularly submit payments to the government. 

Federal Unemployment Tax

U.S. businesses meeting certain employment thresholds must pay Federal Unemployment Tax (FUTA). Employers pay a 6% tax rate on the first $7,000 of each employee’s wages. Employees do not pay FUTA. 

Timely Tax Payments

Your business must submit tax withholding payments to the appropriate taxing authorities. You’ll make payments on a monthly or semi-monthly schedule, depending on the number of employees you hire. Most payments require electronic deposit via EFT.

IRS Publication 15, Section 11 includes in-depth requirements for employment tax payments. Deposit federal and state taxes on time to avoid penalties. 

4. Correct Benefits and Deductions

Does your business offer employee benefits? If so, you should deduct health insurance and retirement plan contributions from your employees’ paychecks.

Notify employees of the benefits you offer. Provide the option to participate or decline benefit plans.

Additionally, track pre-tax and after-tax deductions, including the following common examples: 

• Pre-tax: Health insurance and traditional 401(k) contributions
  
• After-tax: Roth IRA contributions and wage garnishments

5. Timely Paychecks

Facilitate employee satisfaction by paying your workers timely. Establish a consistent pay schedule so your employees know when to expect paychecks. Offer direct deposit if possible. 

Common payment schedules include the following: 

• Weekly: Employers pay employees on the same day each week
  
• Bi-weekly: Employers issue paychecks on the same day every two weeks
  
• Semi-monthly: Employers issue paychecks on the same date each month (e.g., every 1st and 15th)

6. Detailed Recordkeeping

Payroll compliance requires complex calculations and frequent updates for law changes or new employees. Ensure smooth processes by keeping detailed records and documentation. Maintain a secure repository for employee records and sensitive payroll information. 

Further, the IRS requires employers to keep payroll tax documentation for at least four years after the tax was paid (or when the tax was due, if later). 

Payroll tax professionals can help you comply with recordkeeping requirements.  

7. Accurate Quarterly and Year-End Reporting

U.S. employers must submit multiple tax forms to comply with federal and state employment tax rules.

Payroll reporting generally includes the following: 

• IRS Form 940, Employer’s Annual Federal Unemployment Tax (FUTA) Return: File Form 940 annually to report your FUTA liability and payments.
  
• IRS Form 941, Employer’s Quarterly Federal Tax Return: If your annual FICA liability is more than $1,000, file Form 941 quarterly to report your FICA liability and payments.
  
• IRS Form 944, Employer’s Annual Federal Tax Return: If your annual FICA liability is $1,000 or less, file Form 944 annually to report your FICA liability and payments.
  
• IRS Form W-2, Wage, and Tax Statement: File Form W-2 for each employee to report wages, tax withholdings, and deductions. 

8. Compliance with Local Laws

Your business must comply with state, city, and county regulations. Dedicate time to understanding the local laws applicable to your business. 

Consider the following aspects of state and local payroll tax compliance:

• Income tax rates
  
• Minimum wage rules
  
• Recordkeeping requirements
  
• Reporting due dates
  
• Unemployment tax rules

Payroll Software Solutions

Consider using payroll tax technology to streamline your payroll system. 

Payroll software can organize your employee data to calculate employee wages, federal and state tax withholding, and deductions. Some solutions pay workers and track HR information. 

You can free up resources by implementing payroll software to perform complex calculations and keep your employee information current. Payroll providers range in capacity from small business to enterprise-level software, so you can scale usage as your business grows. 

Common Payroll Processing Mistakes to Avoid

Businesses that make mistakes or fail to follow payroll tax rules can incur legal repercussions. Proper payroll tax compliance helps small businesses avoid time-consuming audits and hefty fines.

Common payroll compliance mistakes include the following: 

• Incorrectly classifying employees as independent contractors
  
• Disregarding FLSA overtime wage rules
  
• Failing to keep detailed or updated payroll records
  
• Overlooking state and local laws

You can avoid payroll processing errors by keeping accurate records. Consider partnering with professional payroll providers who can help you stay compliant.  

Importance of Professional Payroll Services

Accurate payroll compliance can be time-consuming. Simple mistakes can cost your company time, penalties, and legal fines.

Professional accountants and payroll experts support your business with thorough and timely recordkeeping. Service providers maintain detailed computations and submit tax filings so you can stay focused on running your business. 

Contact 1-800Accountant for Your Payroll Processing

1-800Accountant offers professional payroll services to help your business stay compliant and avoid costly mistakes. Offload time-consuming calculations to payroll experts who can provide you with detailed records and timely reports. 
Schedule a free consultation with 1-800Accountant to learn how your company can benefit from outsourcing your compliance to payroll professionals.