Updated March 2017
As a small business owner, there are a lot of things that can keep you up at night. But there’s nothing worse than losing sleep because your small business isn't payroll compliant. There’s no such thing as ‘the small stuff’ when it comes to payroll compliance.
What is Payroll Compliance?
In a nutshell, payroll compliance or being payroll compliant means that you're following all the rules and regulations associated with paying employees. In the United States, the biggest enforcer, especially in relation to taxes, is the Internal Revenue Service (IRS).
The IRS doesn’t look kindly on mistakes, even apparently honest ones. The presumption of innocence doesn’t feel like much of a safeguard when the agents come knocking.
12 Steps to Payroll Compliance in the US
How do you know if you're payroll compliant? These are the things you should check:
1. Employee or Contractor
Do you know the difference between an employee versus a contractor? Classifying an employee as a contractor is a critical and potentially expensive early mistake to make as a business owner.
Contractors handle their own taxes, withholdings, social security and compliance issues. They have the same legal and financial obligations as yourself, a fellow business owner. That is not the case with employees. You are responsible for them.
Hiring employees means filling out IRS Form W-2, but with contractors, you have to submit Form 1099-MISC. If you are unsure about the status of your hire, fill out IRS Form SS-8 to get a ruling from the government.
2. New Employee Payroll Records and Reporting
When you hire a new employee, there are forms you need to complete for your records and submit to the government:
- IRS Form W-4 (an annual form for employers to determine withholding taxes).
- IRS Form I-9 or the online E-Verify equivalent is used to determine the employment eligibility status of new employees.
Most states also require new hire reporting to be submitted for all new hires. This is partly to ensure Child Support Orders are being enforced.
Employers who commit I-9 violations can be fined between $110 and $1,100 for paperwork errors. When there’s a clear pattern of hiring illegal team members, you can be fined $16,000 per person and even face criminal charges.
3. Federal Income Tax Withholding and Deposits
Federal income tax for the employer and employee, including social security and Medicare taxes (FICA taxes), must be paid to the government according to your deposit schedule.
You should review IRS Publication 15 before the start of each calendar year to determine the deposit schedule your business needs to use for the coming year. The money should be set aside according to this schedule, with payments sent using Electronic Funds Transfer (EFTPS) for the tax deposits.
Most payroll software providers can handle these tax payments on your behalf. At Wagepoint, we take care of your federal, state, and local tax reporting across all 50 states, the District of Columbia, Puerto Rico and other territories and protectorates.
4. Federal and State Unemployment Taxes (FUTA/SUTA)
Both FUTA and the SUTA are employer paid taxes, paid on separate schedules from the other taxes mentioned above.
SUTA is determined by each state, whereas IRS Form 940 should be filled out every quarter in which the FUTA amount exceeds $500.
5. Quarterly Form 941 Procedures
Every quarter you need to fill out and submit IRS Form 941, keeping the government fully up to date on:
- Tips, bonuses, expenses
- Federal income tax withholding amounts
- Employer and employee share of social security and Medicare taxes
- Any additional Medicare tax withholding amounts
- Quarterly adjustments to social security
- Group-term life insurance amounts
- Plus anything else the government needs
See IRS Form 941 for instructions and updates on how to complete the form accurately.
6. Taxable Wages and Payment Errors
The IRS is not a fan of errors or corrections on Form 941, even honest mistakes. If you make a mistake, you need to submit Form 941-X. The same form can be used to claim a tax refund.
7. Fair Labor Standards Act (FLSA)
The FLSA established the minimum wage, overtime, recordkeeping and youth employment standards covering most employees in the public and private sector.
One impact that employers may not be aware of is that when employees are subject to federal and state minimum wage laws, they are entitled to receive the higher wage, even if it is above the state minimum.
There are many other factors to consider, making it worth checking this handy Department of Labor guidebook.
8. Affordable Care Act (ACA)
The ACA is designed to make healthcare more affordable and accessible for families, seniors, businesses, and taxpayers alike. As a result, millions of people are now insured who weren’t able to get coverage in the past.
Businesses have varying responsibilities, depending on the number of full-time equivalent employees. The IRS has a great resource on the topic of how the ACA affects payroll taxes.
As the ACA has been the subject of debate and even potential repeal, keep an eye on current events. If any changes occur, visit credible sites like the IRS or American Payroll Association (APA) for updates.
9. Final Wage Payments/Termination Pay
Employers should always set out in advance how much final or termination pay is due when an employee leaves or is fired. This should be explained in the employee handbook and/or referenced in employment contracts.
The termination pay is usually based on salary, accrued vacation time, the number of working days remaining, and any severance owed. Some states, such as California, issue their own guidelines, so you should always check with your relevant local department.
10. Garnishment Laws, Child Support, Tax Levies and Rules
Wages can be garnished directly from an employee’s paycheck, depending on the debt and judgment issued on behalf of a creditor.
Some creditors (child support, back taxes and student loans) can legally garnish wages without a judgment, provided the amount is within mandated limits. Depending on the type of creditor, this can be no more than 25% of disposable income or the amount by which your income exceeds 30 times the federal minimum wage, whichever is lower.
Child support has priority, except when an IRS tax levy has been issued before any child support claim.
Tax levies, which are legal seizures to satisfy a debt, can also be issued on wages. A lien can also be imposed as security (similar to a mortgage) against a debt without a seizure taking place. Most states follow federal rules but verify with the state in each case.
11. Resident and Nonresident Aliens
Residents and nonresident aliens are taxed differently, so ensure you determine with the IRS the tax status of all employees to avoid any withholding tax mistakes, even honest ones.
12. Disaster Recovery and Business Continuity Plan
What would happen to your business if disaster struck? Do you have a viable plan in the event of a fire, flood, earthquake, terrorist attack — accidental or not — that affects your IT infrastructure?
Work must carry on. Customers need to be looked after. Employees need paying. The IRS still needs its paperwork and taxes paid on time.
Put together a plan, and then test it. Can business carry on as normal, and how much downtime will you have? What will business recovery cost? Does your insurance cover every possible scenario? Once you have the answers to these questions, you can sleep easier at night.
13. [Bonus Step] Register Your Business and Get Your IDs
As a business owner, especially if you are hiring for the first time, we realize there’s a lot to think about. Wagepoint can help you take care of everything you need from a payroll standpoint so that your business is compliant and your employees are paid on time.
One of the first steps in registering your business with the government is to get your Federal Employer Identification Number (FEIN) from the Internal Revenue Service (IRS).
The next important step in the business registration process is to apply for your state withholding identification number and state unemployment identification number.
These will help state-specific tax agencies associate correctly with your company the withholding and unemployment taxes made by you or on your behalf.
For more information, see our blog post on Registering Your Business for Payroll.
Note: This post was originally published for NextGenJustice in 2015.
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