A Quick Guide To Payroll Compliance

Payroll compliance is a cornerstone of any successful business. By paying employees correctly, withholding the right amount of taxes, and creating a compliance budget, companies can strengthen stakeholder relations while also staying on the right side of the law.

But what is payroll compliance, and how do you do it effectively and legally?

Join us as we explore the importance of payroll compliance and walk you through three ways to do it effectively.

What Is Payroll Compliance?

If you want to understand payroll compliance, it’s important to start by asking yourself one simple question – what does payroll processing mean?

As the name suggests, payroll processing involves accurately calculating all employee’s total wages and taxes withheld and deducted. It’s vital to conduct payroll processing according to state and federal laws – and that’s where payroll compliance comes in.

Areas Of Payroll Compliance

Here are some different areas of payroll compliance.

Wage deductions and social security contributions

The first area of compliance concerns wages. It’s important to comply with both federal and state minimum wage laws as well as laws on late and overtime pay.

It’s also vital to deduct a percentage of your staff’s wages as income tax withholdings and report it to the IRS promptly through one of the following forms:

●      Form 940 for federal unemployment tax

●      Forms 941 and 944 for quarterly and annual federal income, social security, and Medicare tax (where the latter is for small businesses that file returns annually instead of quarterly)

●      Forms W-2 and W-3 (to report wages/tips paid per employee)

It’s also important to note that withholding a certain percentage of your staff’s income for social security is a legal requirement. Businesses are typically required to match amounts withheld per employee dollar for dollar – although this may vary depending on the state in which your business is based.


Another major aspect of payroll compliance pertains to accurate recordkeeping. This refers to the need to keep accurate and complete records of all payroll transactions, such as timesheets, wage slips, and tax forms.

We recommend keeping payroll records dating back to at least 10 years (if possible) in case you’re required to clear your business of income tax-related disputes.

Why Is Payroll Compliance Important?

Here are some reasons why payroll compliance is important.

It Incentivizes Accurate Financial Reporting

Payroll compliance demands accurate financial reporting. By keeping track of all payroll expenses and liabilities, businesses can accurately estimate cash flow and keep operations going.

The idea is simple: businesses with strong payroll compliance have financial reporting methods in place to detect and prevent errors. They are also well-positioned to prepare reliable financial statements to share with stakeholders and conduct accurate audits to prevent fraud.

It Helps with Avoiding Legal Penalties

Payroll compliance also keeps businesses honest about their financial reporting, making them less susceptible to ending up on the wrong side of the law. Many companies avoid legal penalties such as fines and lawsuits by engaging in payroll compliance and keeping their finances airtight.

The primary benefit of payroll compliance when it comes to avoiding legal penalties is the prevention of reputational damage. If businesses don’t display payroll compliance, federal and state authorities can impose sanctions.

For instance, the IRS charges 5% on top of the regular tax bill for each month a business makes a late payment or incorrectly deposits payroll taxes.

It Strengthens Relations with Employees

Another major reason why payroll compliance is important is the positive effect it has on employee relations. Businesses that pay their employees correctly and on time have the best chance of minimizing turnover because employees see the company as transparent, accountable, and reliable.

This perception also boosts employee morale, which in turn raises productivity levels. Working for a company that abides by the law and pays on time makes staff feel respected and assured that they aren’t associated with a company that engages in illegitimate activities.

Some businesses go one step further by engaging in payroll compliance and using payroll on-demand software to win employee confidence. The idea is to show employees the business is so financially compliant that it can disburse paychecks in advance without getting into legal trouble.  

Three Ways To Effective Payroll Compliance 

Here are three ways to manage effective payroll compliance.

Consider Local Laws

One of the main aspects of successful payroll compliance is remaining lawful. It’s important to research local payroll laws and regulations to understand when to pay taxes and how much to pay.

We recommend checking the IRS and Department of Labor websites to find out how much tax your business owes. It’s also worth contacting local authorities for tax advice that is specific to your company, location, and industry – especially if your operations are based in multiple countries.

For instance, if your business also has operations in the UK, look up official government websites that use UK domains (such as the HM Revenue and Customs website) to gain a clear understanding of local tax laws.

Utilize Payroll and RegTech Software

Another key part of effective payroll compliance pertains to technology. Payroll software allows businesses to automate the payroll process and calculate everything from wages to tax deductions and withholdings with a high level of accuracy. In contrast, RegTech software ensures wage equality among employees.

The key is to utilize payroll and RegTech software together so your business complies with federal/local laws and ensures employees are treated fairly at the same time.  

While it may seem like signing up for both kinds of software can negatively impact your budget in the short term, the long-term savings your business stands to make as a result of paying correct taxes, keeping employees happy, and staying ahead of payment deadlines make payroll software and RegTech software worthwhile investments.

Conduct Payroll Compliance Training

Payroll compliance is a team effort, so it’s vital to train any staff who participate in payroll activities. Once they understand how payroll rules and procedures work, your company’s compliance will drastically improve.

It’s useful to provide payroll staff with materials that can help them to carry out compliance checks. This includes checklists, audit manuals, and a guide to local and federal tax laws. If you want to go the extra mile, consider setting up a company phone number that employees or other stakeholders may call to report potential payroll compliance breaches.


Payroll compliance is a straightforward process that requires short-term investments for bigger long-term gains. If you cross-check your company’s current practices against this guide, it’s likely that you’ll quickly spot areas of non-compliance.

Once you know how to improve your company’s payroll compliance, refer to the strategies we outlined in this article to make the necessary improvements, and your company will be on its way to maintaining thorough compliance.

Jesse Liszka – Senior Communications Specialist, Paylocity

Jesse Liszka is the Senior Communications Specialist at Paylocity, a leading provider of cloud-based payroll and human capital management software. She is a highly experienced communications, client marketing, and content specialist with more than 12 years of experience. You can find her on LinkedIn.

Lavanya Rathnam

Lavanya Rathnam is an experienced technology, finance, and compliance writer. She combines her keen understanding of regulatory frameworks and industry best practices with exemplary writing skills to communicate complex concepts of Governance, Risk, and Compliance (GRC) in clear and accessible language. Lavanya specializes in creating informative and engaging content that educates and empowers readers to make informed decisions. She also works with different companies in the Web 3.0, blockchain, fintech, and EV industries to assess their products’ compliance with evolving regulations and standards.

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