Payroll Compliance Checklist for Accurate Payroll

Want to know one of the fastest ways to anger people in multiple departments of your company?

Make a few compliance mistakes in payroll:

• Late paychecks
• Paychecks with withholding mistakes
• Misclassification of employees
• Missed tax filings that cost time, energy, and money in the form of back taxes, interest, and penalties

These are the kinds of mistakes that ruin trust and make people question if a company is “ready for the big time.”

This is especially true in startups and growing companies, where they can derail growth and (in extreme cases) even prevent or delay major events such as an IPO or acquisition.

Even small payroll mistakes create a variety of risks for your business—in ways you may not even be aware of.

Why Payroll Mistakes Usually Happen Without Malice

Most payroll mistakes don’t come from ignorance or negative intent.

Instead, most payroll mistakes are caused by well-meaning people trying their best to get things done using inconsistent, fragmented processes.

Payroll compliance isn’t a one-time task. It’s an operational system that spans wages, taxes, and recordkeeping every pay period.

In this guide, we’ll give you a lifecycle-based payroll compliance checklist you can use for your pre-payroll, payroll processing, and post-payroll obligations, even in a growing company. 

Payroll Compliance Breaks Down in the Gaps Between Pay Periods

Payroll compliance spans more than just running payroll. In fact, a strong payroll compliance system must include every stage of an employee’s journey:

• New-hire onboarding
• Regular payroll cycles
• Annual tax reporting
• Post-employment obligations

Non-compliance at any stage of the process risks:

• Audits
• Penalties
• Employee disputes
• Lawsuits
• Rework and wasted time
• Damaged morale and trust

For all these reasons, a structured, ongoing payroll compliance checklist is a critical tool for a growing business.

The Payroll Compliance Checklist, End to End

Here’s a practical, four-part payroll compliance checklist at a high level:

1. Pre-payroll checks

• Collect and maintain accurate employee data
• Classify employees and contractors correctly
• Verify employment and complete required tax forms

2. Payroll calculations for each pay period

• Calculate employee wages and hours accurately
• Handle payroll deductions and withholdings
• Account for employer payroll taxes

3. Payroll processing

• Set and follow a consistent payroll schedule
• Use payroll software and systems that reduce error rates

4. Post-payroll obligations

• File payroll taxes and reports on time
• Maintain payroll records that hold up under review

Here’s a closer look at each section of the checklist.

1. Pre-Payroll Checks That Set Everything Else Up for Success

Our checklist starts with pre-payroll checks, the steps your team takes during the hiring and onboarding process for a new employee.

Collect and Maintain Accurate Employee Data

Step 1 is ensuring you accurately capture all the data you need for your payroll process. These include:

• Legal names
• Addresses
• Social Security numbers
• Direct deposit details

Store this onboarding data securely to ensure you have accurate records for future audits.

If a new hire's manager does not collect needed information (full name, address, etc.) before the first payroll, flag it right away. Then ask the manager to help get the missing information.

Otherwise, your new hire might experience a delay in their first paycheck, which gives a poor first impression as they begin their tenure.

Classify Employees and Contractors Correctly

Employee classification has become a major conversation in the employment world recently.

To give just one example, Lyft made headlines when it paid $19.4 million to settle a lawsuit in New Jersey about the classification of its drivers as independent contractors. 

Every U.S. state has its own laws and regulations about who must be classified as a full-time W-2 employee instead of a part-time employee or independent contractor. Each employee must also be classified as exempt or non-exempt under the Fair Labor Standards Act (FLSA).

The Lyft example shows that misclassifying employees can cause big problems for companies. Companies must follow the law. This includes federal law and the state and local rules where your employees work.

Verify Employment and Complete Required Tax Forms

Once you’ve verified employment, collect all necessary forms, which often include:

• W-4
• I-9
• Required state forms

Each state also has its own document retention policies, so make sure your compliance program includes guidelines for retention.

Importantly, don’t make the common mistake of failing to report new hires to state agencies on time. Wherever you have team members, you must ensure you’re complying with employment law in the state where employees are based.

2. Payroll Calculations That Must Be Right Every Pay Period

If you have a strong pre-payroll system, you’ll have a foundation you’ll use throughout your regular payroll process. The next step is ensuring you have payroll processes that get it right on every pay cycle.

Calculate Employee Wages and Hours Accurately

Calculating employee wages and hours is trickier than it sounds and gets more complicated with each new employee. 

Ensure you:

• Track employee hours by workweek
• Comply with federal minimum wage and state minimum wage rules
• Calculate overtime pay correctly for non-exempt employees

Handle Payroll Deductions and Withholdings

Payroll deductions are often complex and are a common area for payroll mistakes. In this part of the process, ensure you have a system to correctly withhold:

• Federal, Social Security, and Medicare taxes
• State and local income taxes where appropriate
• State unemployment tax where required

• Pre-tax benefits (401(k) retirement plans, health insurance, health savings accounts, etc.)
• Wage garnishments

Account for Employer Payroll Taxes

In addition to withholding payroll taxes on behalf of employees, employers also have a variety of payroll-related taxes to comply with. As you build your compliance program, ensure you have a process to comply with your responsibilities for:

• FICA (Federal Insurance Contributions Act) taxes
• FUTA (Federal Unemployment Tax Act) taxes

Changes to tax laws also affect payroll planning in a variety of ways. Make sure you have a way to stay current with the laws you must comply with.

For example, if employer-related taxes rise, your total payroll bill will increase. But if employer-related taxes fall, you’ll have lower payroll taxes and additional budget to allocate.

Base rates will also impact your overall tax liability. For example, if Social Security’s wage base increases, higher-income employees will cost more in payroll taxes, even though the tax rate hasn’t changed.

If you incorrectly calculate your payroll tax liability, you could face escalating penalties and late fees from the IRS and state and local tax authorities. 

3. Payroll Processing Without Creating Compliance Gaps

When setting up your payroll system, ensure your process is consistent for each cycle.

Set and Follow a Consistent Payroll Schedule

Ensure employees and managers know what they need to do before the payroll cutoff day. 

If employees need to log hours, ensure they know when those hours are due. If managers need to approve or sign timesheets, give them a firm deadline. Have a process for what happens if employees or managers miss their deadlines, such as automatic approval, delayed payroll, or adjustments to be processed on the next pay period.

Align your payroll timing with federal and state regulations. If you have repeated issues that cause late or incorrect pay, prioritize improving the payroll processing system until it becomes one of the most consistent processes in your business.

Use Payroll Software and Systems That Reduce Error Rates

Manual payroll processing introduces many opportunities for mistakes and increases your compliance risk, especially as your company grows.

Many payroll problems can be eliminated through automation.

Integration with Human Resource Information Systems (HRIS) and accounting tools such as QuickBooks or Xero will prevent many of the problems introduced by humans in the payroll process.

4. Post-Payroll Obligations Teams Commonly Miss

The last phase of our payroll compliance checklist is the post-payroll phase. This is an area where teams often miss some of their compliance obligations.

File Payroll Taxes and Reports on Time

First, companies must file payroll taxes, reports, and their tax return on time. 

This includes Form 941 quarterly filings and Form 940 for FUTA compliance.

At the end of the year, your team must give a W-2 or 1099 form to all employees and independent contractors who meet the reporting rules. For example, you must send most contractors a 1099 tax form at the end of the year as long as they earned more than $600 and were paid by check or direct deposit instead of by credit card.

The IRS requires employers to deposit payroll taxes (federal income tax withholding, Social Security, and Medicare) on either monthly or biweekly schedules. Your company’s obligation to deposit withholdings is not optional, and they are based on the employer’s historical tax liability.

Failing to deposit your required taxes on time can lead to penalties, interest, and fines for non-compliance. 

Maintain Payroll Records That Hold Up Under Review

One way or another, your company’s payroll processes will almost certainly be audited at some point, so ensure you have payroll records that hold up under review. 

Retain payroll records, pay stubs, and tax forms for the required periods in your tax jurisdictions. 

Store your records in a safe and easy-to-access place. Make sure your recordkeeping follows the Department of Labor's advice and local and state rules.

Four Common Payroll Compliance Mistakes That Trigger Audits

Now that we’ve completed our checklist, let’s take a moment to review a few common areas where companies make payroll compliance mistakes that trigger audits. 

1. Misclassifying employees or contractors

Businesses sometimes classify workers as independent contractors to avoid paying employer-related taxes and employee benefits. The IRS or state agencies may challenge this classification. New Jersey did this in the Lyft example we mentioned earlier.

If you call an employee a 1099 contractor but control their schedule, tools, or supervise them, the tax authorities may say the worker is misclassified. Such a misclassification can often lead to audits, back taxes, penalties, and retroactive payroll adjustments. 

2. Incorrect overtime calculations

Incorrect overtime is a frequent cause of audits and penalties. Common errors include:

• Not factoring bonuses or commissions into the regular rate of pay
• Applying the wrong overtime thresholds
• Misclassification of non-exempt employees as exempt to avoid overtime liability

To give an example, the U.S. Department of Labor recovered $1.4 million in wages for 2,620 workers. These workers were denied proper overtime pay by Cupertino Electric Inc., one of the largest electrical contractors in California.

3. Missed filings or late tax payments

Without a strong process, it’s easy to forget to pay your taxes on time.

As an employer, you must withhold the correct amounts, file the correct reports, and send your payments on time, every time. Failing to do so is a common cause of audits, penalties, and interest payments.

These issues can escalate quickly, especially if filings are repeatedly late or incomplete. Missed federal or state deadlines can trigger:

• Automated notices
• Wage garnishment orders
• Holds on business bank accounts

In some cases, repeated non-compliance may lead to more frequent audits, creating ongoing burdens for your finance and payroll teams.

4. Incomplete or inconsistent payroll records

Incomplete and inconsistent payroll records are another common sign of a fragmented payroll system. 

We’ve seen companies that had missing timesheets and conflicting information about pay rates. We’ve also seen poorly documented tax withholdings and records that showed employees were paid amounts that differed from what they actually received.

These are issues that can easily cost days and weeks to untangle. They are also issues that can be avoided with a strong end-to-end payroll compliance program we hope this checklist helps you create. 

Where Payroll Compliance Connects to Broader Tax Risk

There’s one additional angle we need to cover when it comes to payroll tax compliance: the broader tax risks.

So far, we’ve been discussing the direct implications of failed payroll compliance. But payroll issues can also trigger larger tax problems for your business.

Employees Can Trigger Physical Nexus

One of the biggest tax risks comes from where your employees actually work.

In many states, hiring someone based in the state triggers a physical nexus, meaning the state now considers your business to have a physical presence in its jurisdiction. 

Once that happens, the state may require you to follow all its commerce rules, and not just for payroll laws. Specifically, hiring a remote employee in another state may trigger:

• New payroll tax registrations
• State income tax withholding rules
• State unemployment insurance requirements
• Sales tax responsibilities, even if you don’t sell in the new employee’s location

That last one—sales tax responsibilities—is one of the biggest problems to look out for. This can also be an especially difficult issue if you’re managing SaaS sales tax compliance and tax remittance with customers in a variety of locations.

If you don’t understand and abide by a state’s payroll regulations, they can come after you for missed filings, late payments, or back taxes, penalties, and interest.

This is why payroll tax compliance matters so much. 

It’s not just about paying people correctly and on time. It’s also about protecting the business from unexpected downstream tax exposure.

How Sphere Helps Teams See These Risks Early

Sphere helps teams spot the sales tax risks tax we’ve been talking about above—before they become problems.

We connect directly with all major HRIS solutions. When you add a new employee, change someone’s work location, or update their role, Sphere pulls that data automatically. Sphere also uses location data from your system to watch for these changes. 

When the system finds a change that could impact your sales tax obligations, it will notify you. This gives you a chance to manage your responsibilities before they become a problem.

In this way, your payroll data becomes more than a record of who gets paid. It becomes a key input for your global tax compliance system.

Ready to simplify SaaS sales tax compliance?

Schedule a demo with Sphere today.

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Payroll Compliance Works Best When the System Does the Heavy Lifting

If you take anything away from this article, make it this: payroll compliance works best when the system does most of the work for you.

When you rely on manual steps, spreadsheets, and memory, you risk missing deadlines and forgetting important details. You may even inadvertently create a physical nexus, exposing your company to a host of compliance issues and potential new tax obligations.

Automation and strong financial reporting tools can streamline many of the manual handoffs that create problems. It also helps you establish clear ownership of the different steps of your system.

Sphere’s platform doesn’t replace a payroll provider or a payroll team, but it can help track related obligations associated with sales tax. It connects payroll, HRIS, and transaction data to create a clearer picture of your payroll-related obligations, especially your indirect tax obligations.

This helps your team operate more efficiently and avoid many of the common payroll-related compliance mistakes we’ve covered in this article. 

Payroll Compliance Is a System You Either Control or Chase

Done right, a strong payroll program is a bit like a good sports official or referee: they do their jobs quietly and don’t call much attention to themselves. 

Just like a poor referee, however, when your payroll isn’t doing its job, everyone feels the pain of the mistakes, and the situation can easily snowball into a much larger problem.

Take the time to invest in a strong payroll compliance system as early as you can, and while you’re at it, we invite you to take a look at how Sphere’s payroll tax compliance software can help.

We know that payroll isn’t the most glamorous system in your business.

If you’re like most business leaders, you’d rather spend your time talking about product innovations, hiring all-star talent, or your latest creative marketing and sales campaigns.

But payroll is just as important to a well-run business, especially a growing business or startup. And a strong payroll compliance system will reduce long-term tax and audit risks for years to come.