Payroll Compliance Legislation and Common Mistakes

When you run payroll, you must comply with payroll and labor laws. Brush up on payroll compliance legislation and common compliance mistakes so you can accurately run payroll without fear of penalties.

Payroll compliance legislation

All employers must follow payroll compliance legislation. While it might seem like a burden, it’s extremely important. Why is payroll compliance legislation important? It makes sure employees are paid and treated fairly. And, legislation ensures that governments receive the funding they need for certain programs.

Below are payroll compliance laws you must follow.


The Fair Labor Standards Act (FLSA) regulates minimum wage, child labor, overtime laws, and recordkeeping.

The FLSA sets the federal minimum wage at $7.25. You must pay employees at least this much per hour. You might have to pay even more if your state or locality has a higher minimum wage.

The Act includes child labor laws to protect workers under the age of 18. It regulates the types of jobs children can do at certain ages, what times children can work, how many hours children can work, and how much you must pay children.

Because of the FLSA, many employees are entitled to extra wages when they work overtime. Overtime wages are 1.5 times an employee’s regular rate of pay.

You must give overtime wages to nonexempt employees, but you don’t need to give overtime wages to exempt employees. The FLSA sets the rules for determining exempt vs. nonexempt employees.

The FLSA requires you keep certain information about your employees on file. For example, you need to have the each employee’s full name, Social Security number, occupation, and details about their wages. For a full list of information you need to keep, consult the U.S. Department of Labor.

You must keep payroll records for at least three years. And, you must keep documents that involve wage calculations, such as time cards and deduction information, for at least two years.

Economic realities test

The economic realities test isn’t really a law so much as it is a guide. It helps you determine if the people who work for you are independent contractors or employees. Employees have certain rights that independent contractors don’t have, such as overtime wages.

The economic realities test looks at multiple things, including:

  1. Does the performed work relate to your business?
  2. How permanent is the worker?
  3. How much does the worker invest into doing the job?
  4. How much control do you have over the worker?
  5. Does the worker have opportunities for profit and loss?
  6. How much skill and judgment does the worker need?

You cannot look at one part of the test by itself. You must consider all parts together.


Federal legislation requires you hold several types of taxes from employee wages.

FICA taxes

The Federal Insurance Contributions Act (FICA) created federal programs for old-age, survivors, disability, and hospital insurance. These programs are funded by Social Security and Medicare taxes, sometimes referred to together as FICA tax.

FICA taxes have two parts: the employee withholding and the employer contribution. You will withhold part of Social Security and Medicare taxes from employee wages. And, you will contribute an equal part to meet full payroll tax compliance.

Federal income tax

You withhold federal income tax from employee wages. The federal government uses the money collected from federal income tax to fund government programs, such as defense, education, and health care.

Federal income tax withholding is different for every employee. To calculate federal income tax, you need information from an employee’s Form W-4 and the income tax withholding tables.

FUTA tax

The Federal Unemployment Tax Act imposes a tax on employers. FUTA tax funds the federal government’s oversight of state unemployment programs.

Many employers receive a FUTA tax credit, which reduces their tax rate. However, employers in credit reduction states will receive a smaller tax credit, therefore increasing their FUTA tax rate.

Other federal laws

Numerous other federal laws affect your payroll reporting compliance.

For example, there’s the Equal Pay Act, which requires you to pay men and women equal wages for equal work at the same establishment. And, there’s the Consumer Credit Protection Act (CCPA), which prohibits you from firing an employee because you must garnish wages from their pay. The CCPA also limits how much you can garnish from employee wages.

To learn more about labor and payroll laws, check out our guide to federal employment laws.

State laws

On top of all the federal laws, each state has its own laws, too. Your state likely has laws on pay stubs, acceptable ways to pay employees, state unemployment insurance, workers’ compensation, new hiring reporting, state income tax, and more. You must also follow these payroll compliance requirements.

Be sure to check out your state payroll and labor laws to remain compliant.

Common payroll compliance mistakes

With so much legislation, it’s easy to make payroll compliance mistakes. Mistakes lead to fines and penalties.

Below are common payroll compliance mistakes employers make. Take note of them so you can avoid these mistakes in your own payroll. You can try using a payroll compliance checklist so you don’t miss anything when you run payroll.

Misclassifying employees as contractors

Many employers misclassify workers as contractors when they should really be employees. This is a huge mistake.

You pay an employee through your regular payroll. You will give the employee regular paychecks, and you will withhold taxes and other deductions from their wages. After every year, you will give the employee a Form W-2, which breaks down the employee’s wages, taxes, and deductions for the year.

When you pay an independent contractor, their pay is not part of your payroll. It’s an outside payment. You do not withhold taxes or any other deductions. After every year, you will give the contractor a Form 1099, which tells how much you paid them.

If you misclassify workers, the workers and governments miss out on money. The workers possibly miss out on a minimum wage and overtime wages. Governments lose tax money that they would normally get from employee wages.

Misclassifying exempt workers

Some employees are exempt from overtime wages, meaning you do not pay them overtime wages. Some employees are nonexempt, meaning you must pay them overtime wages if they work any overtime.

The FLSA says an employee can be exempt from overtime wages if they fall under one of the following exemption types:

  • Executive, administrative, or professional exemption
  • Computer exemption
  • Outside sales exemption
  • Highly compensated employee exemption

If you misclassify an employee as exempt, they will miss out on wages. You will owe them back wages, including wages at the overtime premium.

Miscalculating overtime

It’s important to pay your nonexempt employees correctly for any overtime they work.

You must use the overtime premium when calculating overtime pay. The premium is time and a half, meaning you will multiply the regular rate of pay by 1.5. For example, if an employee normally earns $10 per hour, you will pay them $15 per overtime hour.

You have to start paying the overtime premium once an employee works more than 40 hours in a workweek. You cannot average out the worked hours over several weeks. For example, an employee works 35 hours one week and 45 hours the next. Even though that averages out to 40 hours per week, you still must pay overtime wages for the extra time worked during the second week.

You must also follow your business’s payroll workweek. A workweek can be different than a calendar week or pay period. Once an employee works more than 40 hours in a workweek, you must begin paying overtime wages. You cannot move the workweek to avoid paying the overtime premium.

Failing to maintain records

You must keep payroll records for all employees. Make sure you have a secure way to store them.

Certain federal, state, or local government agencies might request to see your payroll records, especially if they suspect an issue. If you are unable to produce the records, you might face fines.

It’s good to keep records on hand in case there’s a legal dispute. If an employee sues you for a payroll issue, you can use your records as evidence.

You might use a traditional filing cabinet to keep paper copies. The filing cabinet should have a lock. Access should be limited only to people who handle payroll tasks.

You can also store records digitally. HR document software can help you with this. Simply upload documents into the software.

Forgetting to report taxes

You must regularly file forms to report your employment tax liabilities. This applies to both employee and employer-paid taxes. Missing the deadline to file the form can result in penalties.

The deadline to file the forms depends on the tax.

For federal income and FICA taxes, most employers will use Form 941 to report taxes liabilities on a quarterly basis. The due dates are:

  • April 30 for Quarter 1
  • July 31 for Quarter 2
  • October 31 for Quarter 3
  • January 31 for Quarter 4

Some employers may receive permission from the IRS to file Form 944 instead of Form 941. If you receive this permission, you can file Form 944 annually by January 31.

For FUTA taxes, all employers use Form 940. You must report your taxes on this form each year by January 31.

Make sure you check the filing dates for your state taxes.

Missing deposit dates

You must deposit employment taxes more frequently than you file them. This can lead to some confusion and result in missed payments. And, missed payments result in late fees.

For federal income and FICA taxes, you will either deposit the taxes on a semiweekly or monthly basis. Your deposit schedule can change every year and is based on a lookback period.

You will pay FUTA taxes on a quarterly basis. However, if your FUTA tax liability is $500 or less during a quarter, you don’t have to deposit the tax. Instead, carry it over to the following quarter. Once your liability reaches more than $500, you must deposit the tax by the quarterly deadline.

Withholding garnishments improperly

You might have to garnish an employee’s wages for unpaid taxes, overdue child support, outstanding medical bills, and delinquent or defaulted loans.

You must withhold garnishments on most types of earnings, including regular and overtime wages, salaries, bonuses, and commissions. But, you do not garnish tip income.

There are restrictions on how much you can garnish from employee wages. Even if you have a court order saying you must withhold a certain percentage, you might be limited by laws to withhold a lower amount. This protects the employee’s wages and ensures that the employee still has earnings.

The maximum amount you can withhold is determined by the Consumer Credit Protection Act. Your state might also have laws protecting garnishees. Make sure you check all applicable laws so you don’t withhold too much from employee wages.

Failing to withhold taxes on fringe benefits

Benefits are a great way to attract and keep employees. Some fringe benefits are taxable, such as bonus pay, paid time off, and the use of business vehicles outside of work. You must withhold income and FICA taxes. And, you must pay unemployment taxes and your portion of FICA taxes.

You can make payroll compliance easier when you use Patriot’s online payroll software. We’ll make sure your calculations are correct. And, if you use our Full Service Payroll option, our payroll services take care of filing and depositing your employment taxes. Get started with a free trial.

This article has been updated from its original publication date of November 10, 2017.

This is not intended as legal advice; for more information, please click here.

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