When you become an employer, you must follow all payroll laws to avoid financial penalties, lawsuits, and even worse, being forced to close your business. Payroll laws specifically govern how you pay your employees and taxes as well as how you report this information. To name a few, this includes overtime pay requirements, payroll taxes, and quarterly and annual tax forms. You must follow both federal and state laws to maintain payroll compliance; state laws, which vary based on your location, seem to trip some employers up more.
While it’s important that small business owners have knowledge of payroll tax laws, some opt to use a payroll service, like Gusto, to help reduce their chances of breaking the rules. Gusto makes it easy to comply with payroll tax laws, because it tracks all changes, both federal and state. It also withholds and pays the taxes for you and prepares IRS reports. Try it free for 30 days.
1. Payroll Taxes Must Be Calculated Correctly & Paid On-Time
When doing payroll, you must withhold the correct amounts of payroll taxes from employee paychecks and pay them as required (monthly, quarterly, or annually). There are federal and state payroll taxes, and you’ll need to determine the appropriate tax rates to ensure your calculations are correct. There are also employer payroll taxes you must pay out of your own bank account—you’ll pay the same amount in Social Security and Medicare taxes as you withhold from employee paychecks.
Specifically, you need to withhold the following federal taxes from employees’ paychecks—state taxes vary, depending on the state:
- Income tax
- Social Security
In the News:
Due to COVID-19, the federal government passed some laws to give employers and employees relief. If you took advantage of the employer payroll tax deferral or opted in to the payroll tax holiday for employees, you’ll need to pay the money by the new deadlines—they begin in January 2021.
2. Most States Require You to Purchase Workers’ Compensation Insurance
Another important law that affects your payroll compliance is the workers’ compensation insurance requirement. Most states require you to purchase workers’ compensation to cover potential expenses from on-the-job injuries by employees. It’s usually funded through private entities and is regulated and overseen by the state.
There are very few exceptions to the workers’ compensation requirement—Texas is the only state in which employers can opt out of purchasing the insurance. So, if you are a new business that doesn’t operate out of Texas, do not skip this step. Many payroll services give you the option to purchase workers’ comp through one of its partners or its own in-house products.
3. Employers Are Responsible for Managing Court-Ordered Garnishments
There may be times when you receive a court order to withhold funds from an employee’s paycheck to cover a debt. This is serious, and you must act quickly, or you could be responsible for paying the funds later. You’ll typically receive an income withholding order if an employee is behind on child support. You can also receive an earnings withholdings order for other debts that other parties have been awarded in a lawsuit.
4. Tax Forms Must Be Filed by Their Deadlines
Employers must report the taxes they withheld and paid to the IRS and other tax agencies, so they can verify. Some reports must also show total income paid out, in particular the year-end W2 forms that are required to be mailed out by Jan. 31. If you’re using contractors, you’ll need to send 1099 forms. There are many other payroll forms employers may need—some at the beginning of an employment relationship and others more regularly, like quarterly.
5. Keep Payroll Records on File for Three to Four Years
You are responsible for several recordkeeping requirements for payroll, which may not seem intuitive when thinking about payroll. One best practice many employers follow is to keep all payroll records, like paycheck stubs, year-end tax forms, new hire tax forms, time sheets, etc., for at least four years. The law allows you to keep some of them for a minimum of three years.
Employers may use any timekeeping method they want to, but records must be complete and accurate and untampered with by the employer, aside from a supervisor sign-off. Employers may not alter timecards. The following is a sample time card format employers can use. Be sure to include total hours worked, meal and rest times, and the employee’s signature.
6. Some Employees Must Be Paid Overtime & Minimum Wage Is Required
Federal law requires you pay employees extra if they work overtime. In addition, there are minimum wage amounts you must pay to each employee depending on which state you’re operating in. There are overtime and minimum wage exemptions, but you’ll need to familiarize yourself with them to ensure the employee situation you’re considering is eligible.
Overtime Pay Rules
You’ll need to separate your exempt employees and non-exempt ones. Non-exempt employees must be paid overtime when they work over 40 hours during a week (usually hourly workers but can be salaried too); exempt employees are not entitled to overtime pay. Overtime pay is paid at the time and a half rate (1.5 times their regular hourly rate). If you neglect to acknowledge overtime when required, you will be in violation of the Federal Labor Standards Act and will have to repay the money plus late fees and penalties, eventually—not to mention you’ll have to pay additional taxes on the wages too.
Did You Know?
Beginning Jan. 1, 2020, any employee earning less than the new salary threshold, $35,568 per year for a full-time worker, will be eligible for overtime pay. The other way to calculate this is by assessing the standard weekly salary level, which was raised from $455 to $684.
Minimum Wage Rules
You can’t just pay employees what you think they’re worth; the federal government and many states have established a minimum wage amount you must pay to maintain payroll compliance. Federal minimum wage is $7.25 an hour, but many states have even higher rates—some up to $15.00 an hour. Check your state labor website every year so you’re always following payroll laws; the rates can change yearly.
7. Employees Must Be Paid on Time
When you start paying employees, it is important to set a pay schedule on which they’re regularly paid. Weekly, biweekly, and semimonthly are the most common pay periods, but some businesses pay out monthly. Each state has its own minimum pay frequency requirements, so be sure to check yours.
There is no requirement that companies must pay their employees via direct deposit. Most employers offer direct deposit as it is easier to process payroll, as well as allowing employees to get their money faster. Approximately 82% of employees receive their pay via direct deposit.
8. Multiple Payroll Options Are Sometimes Legally Required
Usually, employers have autonomy in determining their preferences on how to pay employees, whether that be by paper check or direct deposit. However, since the use of pay cards is starting to increase, some states have passed laws requiring employers to offer an additional pay option beyond just that.
Also, contrary to what some believe, employers can pay employee paychecks in cash. The important thing is to learn how to pay employees cash legally. Proper documentation is one of the most important factors that will help you avoid fines and penalties.
9. Specific Rules on Paying Tipped Employees Must Be Followed
If you operate within the foodservice industry and if some of your employees receive tips or are part of a tip pool, then you need to be aware of tip reporting laws. This is incredibly useful if tipping pools are a part of your business.
One common challenge that many foodservice employers encounter is how minimum wage can be governed within jobs that also are eligible for tips. If you are new to this arena, it is a huge deal. For example, many states can pay their tipped employees a tipped minimum wage, which is a rate that is below the state’s required minimum wage, with the concept being that these employees get paid from the restaurant plus their tip “wages.”
Some states do not allow this practice; these states are known as “equal treatment states” and include Alaska, California, Hawaii, Minnesota, Montana, Nevada, Oregon, and Washington. Other tip wage laws differ significantly from state to state, so research your state laws carefully.
How to Remain Current With Payroll Compliance Laws
According to the National Small Business Association (NSBA), the top two burdens on small businesses are income and payroll taxes. These administrative- and financial-related burdens can be so time-consuming and complex, due to their evolving nature, small business owners often find themselves spending an excessive amount of time completing them.
If you have chosen not to employ a payroll service to assist you with these regulatory responsibilities, then you’ll need to learn how to do payroll yourself. Plus, you’ll have to stay abreast of any changing payroll laws.
We recommend that you take the following actions on an annual basis:
- Hire an auditor to review your payroll records, processes, and procedures. You can also conduct your own payroll audit.
- Sign up for the e-newsletter from the Small Business Administration (SBA).
- The DOL offers useful, easy-to-find payroll regulatory information on the FLSA and other payroll-related laws.
- Although you will need to maintain an annual membership, the Society of Human Resource Management (SHRM) retains a wealth of knowledge regarding payroll compliance laws, including details of the FLSA. Annual SHRM membership costs $209.
- The American Payroll Association (APA) provides solid resources listed that no small business owner should be without. For example, we like the Compliance Calendar, which outlines critical payroll filing dates that are challenging to find anywhere else. The Compliance Calendar is a terrific tool that helps small teams stay on top of the many evolving tax filing rules and their dates throughout the year.
Agencies That Regulate Payroll Laws: IRS & DOL
The institutions that govern payroll law nationwide, the IRS and DOL, are what we look to as payroll laws evolve. The IRS oversees, in large part, that taxation portion of payroll compliance. The DOL manages the aspects that differ from state to state but, more specifically, how the FLSA impacts payroll processing.
IRS Payroll Regulations
If you have tax-related questions regarding payroll, then visit the IRS website, which outlines what you need to know as it relates to what taxable income is for employees, how to maintain tax records properly, how payroll taxes are affected by company mergers, how to report payroll tax of a deceased employee, and more.
DOL Payroll Regulations
If you have questions about the ever-expanding FLSA, then visit the DOL website, which helps you navigate the payroll regulations that can vary significantly from state to state. For example, in the states of Alabama, Arkansas, Florida, and Mississippi, employers are not required to offer pay stubs to employees while approximately 25 other states do require that employers provide pay stubs to employees.
The DOL’s website lays out how the FLSA impacts payroll law compliance for the average employer. These payroll categories range from the minimum required (paid) rest periods and minimum wages from state to state to agricultural employment-related payroll regulations. The DOL’s minimum wage guide easily helps employers determine what their wage responsibilities are to their employees.
Payroll processing and its related compliance requirements can be complicated to manage in the long term due to a multitude of payroll laws that are complex and ever-evolving. Helpful resources and payroll partners can help. Although the IRS and DOL offer copious amounts of resources, they each are somewhat unforgiving when it comes to oversights or poor practices; you can face expensive penalties for even unintentional oversights, so it’s important to stay abreast of changes.