Payroll Compliance Legislation & Common Mistakes

In the ever-evolving landscape of business operations, one critical area that demands unwavering attention is payroll compliance legislation. And that’s all the more true in a world where cross-border employment is constantly on the rise.

According to a recent survey conducted by Indeed Hiring Lab, 64% of nearly 3,000 companies said they are likely to hire foreign nationals. The demand for foreign workers is enticing millions of people to look for work outside their home countries; data from hundreds of millions of job searches and postings on Indeed shows that between 2019 and 2022, almost 800 million cross-border job searches were carried out.

As more companies operate across borders, and a larger percentage of their workforce is spread out across different countries, payroll compliance becomes more challenging. While Payroll compliance legislation has the same goal across the globe – to protect the rights and interests of both employers and employees alike – each country’s legal framework is different, and global companies must be aware of these differences.

Whether you are an established enterprise seeking to fortify your compliance practices or an entrepreneur embarking on a new venture, learning the ins and outs of payroll compliance legislation is paramount to success in the modern business landscape. And something any global company could use guidance on.

What Is Payroll Compliance?

Payroll compliance means adhering to all laws, regulations, and legislations governing employees’ compensation.
It involves accurate calculations of wages, tax withholdings, and benefits, in addition to meeting legal requirements for payroll reporting, record-keeping, and payment timelines. Failure to comply with payroll legislation can lead to various sanctions that could negatively affect business operations.

Payroll compliance encompasses the necessary actions that employers need to take in order to comply with tax regulations, wage and hour rules, and other relevant legal requirements associated with payroll.

9 Common payroll compliance mistakes

1. Misclassifying employees as independent contractors

Employee misclassification is the illegal practice of labeling workers as independent contractors – usually to reduce labor costs – when they should be classified as employees. Misclassifying employees as contractors can expose employers to investigations, sanctions, and compensation lawsuits.

With more and more companies relying on independent contractors, worker misclassification has become a serious issue globally. Food delivery company Foodora Australia, for example, was charged with misclassifying its rider as independent contractors. The company admitted that their riders were more likely to be employees, and were entitled to more than $5 million in unpaid wages.

In another example, a federal investigation in the US has yielded $700,000 in back wages, damages, penalties, and other guarantees for more than 1,000 construction workers who were wrongly classified as independent contractors.

It was also reported recently by TechCrunch, that California Senator Urges Investigation into Deel’s Business Practices: Allegations of employee misclassification and tax evasion spark scrutiny.

2. Misclassifying employees as “exempt”

Salaried employees in the US are classified as “exempt” or “nonexempt” from receiving overtime pay, based on the requirements outlined in the Fair Labor Standards Act (FLSA).

Exempt employees are typically executive, administrative, or professionals who meet certain criteria, such as having specific job duties and earning a minimum salary threshold. Non-exempt employees, on the other hand, are entitled to receive overtime pay for hours worked beyond the standard 40-hour workweek.

Misclassifying employees as exempt from overtime pay can have serious legal and financial consequences for employers. Firstly, employees who are wrongly denied overtime pay may be entitled to back wages for unpaid overtime hours. This can result in significant financial liabilities for employers, including back pay, liquidated damages, and attorney fees.

In addition, exempt employee misclassification can result in legal action, as employees have the right to file complaints or lawsuits against employers who violate wage and hour laws.

3. Miscalculation of overtime pay

Another common payroll compliance mistake. Failing to accurately calculate and provide compensation for working beyond regular working hours can result from misunderstanding overtime calculations, errors in timekeeping, or the inclusion of non-qualifying payments – bonuses, commissions, or certain types of allowances – in overtime pay.

Miscalculations of overtime pay can result in employees being underpaid for their extra hours. This can have legal and financial implications, such as employee complaints, investigations by labor agencies, potential lawsuits, back wages payments, and penalties.

4. Miscalculating withholding payments

Withholding payments are deductions made from employees’ wages to cover various obligations. For example, employers are responsible for withholding payments for various employment benefits, such as health insurance premiums, retirement contributions, and social security taxes. Miscalculations can occur when errors are made in determining the correct amount to withhold based on employee contributions and applicable tax rates.

Fringe benefits – such as company-provided vehicles, housing allowances, or non-cash compensation – also impact withholding payments. Employers need to accurately calculate the taxable value of these benefits and withhold the applicable taxes. Errors in calculating fringe benefits can lead to incorrect tax withholdings and potential non-compliance with tax regulations.

Another type of withholding is garnishments. When employees have court-ordered garnishments, such as child support or creditor garnishments, employers must withhold the specified amounts from employees’ wages and remit them to the appropriate entities. Miscalculations could happen if incorrect or outdated garnishment orders are used, resulting in either under-withholding or over-withholding.

Miscalculating withholding payments can have several negative consequences. It can result in underpayment or overpayment of employee benefits, leading to financial discrepancies and potential dissatisfaction among employees. Moreover, errors in withholding taxes can result in incorrect tax reporting, potential penalties from tax authorities, and the need for costly corrective actions.

5. Failure to report taxes on time

Tax authorities, such as the Internal Revenue Service (IRS) in the United States, require employers to report payroll taxes within specified deadlines. These deadlines are typically monthly, quarterly, or annually, depending on the jurisdiction and the tax type.

For example, employers are responsible for withholding and reporting various payroll taxes on behalf of their employees, such as federal income tax, Social Security and Medicare taxes (also known as FICA taxes), and state and local income taxes where applicable. Employers must calculate and report these taxes timely to comply with tax laws and regulations.

Failure to meet these deadlines can result in penalties, fines, interest charges, and legal actions. In addition, it can raise concerns among employees, business partners, and stakeholders about the company’s financial management practices. It may also impact relationships with tax authorities and other regulatory bodies, potentially triggering further scrutiny and investigations.

6. Incorrect W-2 tax form

Form W-2 is used to report employees’ wages and tax withholdings to the Internal Revenue Service (IRS) in the United States. Filing an incorrect W-2 tax form can occur because of inaccurate employee information, errors in wage and tax reporting, and failure to incorporate periodic changes in tax laws in the W-2 form.

Filing an incorrect W-2 form can lead to a range of consequences. For employers, it can trigger IRS penalties for failing to provide accurate and timely information. Employees may also experience difficulties when filing their tax returns, potentially leading to delayed refunds or audits.

7. Inaccurate tracking of employees’ work hours

Accurately tracking work hours is essential for determining employee compensation, including regular wages, overtime pay, and other applicable wage-related benefits. It ensures that employees are paid correctly and in compliance with labor laws.

Inaccurate tracking of employees’ work hours can have various explanations, such as incorrect recording of clock-in/out times, missed entries, rounding inaccuracies, failure to account for all work-related activities, and lack of automated timekeeping systems.

Failure to accurately track employees’ hours can lead to legal consequences, such as wage and hour disputes or investigations by labor authorities. Non-compliant businesses may be subject to penalties, fines, and requirements to pay back wages. Additionally, employees who feel their hours are not accurately tracked may become dissatisfied, resulting in lower retention rates.

8. Failure to keep payroll records

Employers are legally obligated to maintain accurate and comprehensive payroll records. These records typically include employee identification, employment dates, wages, tax withholdings, benefits, and other relevant employment details.

Failure to maintain payroll records increases the risk of non-compliance during payroll audits or investigations by government agencies. Payroll records also play a critical role in ensuring compliance with tax regulations and in case of employee disputes or claims.

Businesses that fail to maintain payroll records leave themselves vulnerable to errors in wage payments, miscalculated benefits, and incorrect tax filings, which can trigger penalties, fines, audits, and additional scrutiny.

9. Late payroll payments

Timely payment of wages is the most crucial aspect of payroll compliance. Labor laws and regulations in most jurisdictions specify the frequency and timing of payroll payments. Missing the deposit dates – due to holidays, time gaps, or other reasons – can have several implications.

In some jurisdictions, companies may face penalties, fines, or other sanctions for not complying with payment timelines. Government agencies responsible for labor enforcement can conduct investigations or audits, which may further disrupt business operations and result in additional penalties if violations are found

What tasks does payroll compliance include?

• Calculating payroll: this process includes calculating regular pay, overtime pay, bonuses, commissions, and any other applicable earnings. It also involves considering various factors such as employee classification, tax deductions, and benefit contributions.
• Paying employees: the disbursement of funds based on the calculated payroll. It includes ensuring that payments arrive on time and through the agreed-upon payment method, such as direct deposit or physical checks.
• Filing payroll-related government forms: employers must submit various forms that report employee wages, tax withholdings, and other payroll-related details. In the US, this typically includes forms such as W-2, W-3, 1099, 941, and state-specific forms, depending on the jurisdiction.
• Submitting withholdings from employee pay: this includes income tax withholding, Social Security contributions, Medicare taxes, and any other applicable deductions such as health insurance premiums or retirement plan contributions.

  Employers must calculate the correct amounts to withhold based on employee earnings, filing status, and applicable tax rates. These withheld amounts must be remitted to the appropriate government agencies, typically quarterly or monthly.

• Submitting employer-owed payroll taxes: the payment of taxes that employers are required to contribute based on their payroll. This typically includes employer portions of Social Security and Medicare taxes, federal and state unemployment taxes, and any other payroll-related taxes specified by the jurisdiction.
• Filing end-of-year payroll taxes and reports: this includes annual payroll tax returns and reconciling payroll tax information for the entire year. Employers must meet the specified filing deadlines and retain appropriate records to support the information reported in these filings.

Payroll compliance legislation in the US

• Federal income tax: requires employers to withhold a portion of employees’ wages based on the employee’s tax withholding status, exemptions, and taxable wages. The withheld taxes are reported and paid to the IRS. (Here is how to file for it)
• Employee classification rules: guidelines established by the IRS and other government agencies to determine whether a worker should be classified as an employee or an independent contractor.

  Proper classification is crucial as it affects various aspects of payroll compliance, such as tax withholding, benefits eligibility, and labor law protections. The rules consider factors such as the level of control exerted by the employer, the worker’s independence, and the nature of the working relationship. (the guidelines can be found here)

• Fair Labor Standards Act (FLSA): a federal law that establishes minimum wage, overtime pay, and recordkeeping standards for employees in the United States. Under the FLSA, employers must pay non-exempt employees at least the federal minimum wage for all hours worked and provide overtime pay at a rate of one and a half times the regular hourly rate for hours worked beyond 40 in a workweek.

  The FLSA also regulates child labor, setting restrictions on the types of work, hours, and conditions in which minors can be employed.

• Federal Insurance Contributions Act (FICA): requires employers and employees to contribute to two federal programs: Social Security and Medicare. FICA taxes are withheld from employees’ wages to fund these programs. Employers are responsible for withholding the employee’s portion of FICA taxes and must contribute an equal amount on behalf of the employee.
• Equal Pay Act (EPA): a federal law that prohibits wage discrimination based on gender. Under the EPA, employers are required to provide equal pay to employees who perform jobs that require equal skill, effort, and responsibility, and are performed under similar working conditions.
• Federal Unemployment Tax Act (FUTA): employers must pay unemployment taxes to fund state unemployment compensation programs. The FUTA tax rate and wage base are set by federal law, and employers are responsible for calculating and remitting these taxes to the IRS.
• Employee fringe benefits: compensation and perks employers provide beyond regular wages or salary, such as health insurance, retirement plans, paid time off, transportation benefits, educational assistance, and more. Employers may need to withhold and report taxes on certain fringe benefits, while others may be tax-exempt or subject to special tax rules.
• State regulations: in addition to federal payroll compliance legislations, employers must adhere to state-specific laws that can impact various aspects of payroll management. Some notable state regulations for payroll compliance include State Income Tax, State Minimum Wage, State Unemployment Insurance (SUI), State Disability Insurance, State Wage and Hour Laws, and State Paid Sick Leave.

The cost of non-compliance with payroll legislation

The cost of non-compliance with payroll legislation can vary depending on several factors, including the jurisdiction, the nature and severity of the non-compliance, and the number of affected employees.

In the US, for example, employers who willfully or repeatedly violate the minimum wage or overtime pay requirements are subject to a penalty of up to $1,000 for each such violation. In 2022, more than 30,000 employees in the US received $17,941,190 in back wages due to non-compliance with minimum wage legislation, while more than 110,221 employees received $134,591,521 in back wages because of failure to comply with overtime pay regulations.

Unfortunately, a large share of these penalties result from payroll errors. A recent Ernst & Young survey, which collected responses from more than 500 payroll professionals working for companies with 250 to 10,000 employees, found that 20% of payrolls in the US contain errors, each costing an average of $291.

Another cost of non-compliance with payroll legislation is unnecessary litigation. 14% of the companies surveyed by EY indicated they had litigation issues related to payroll errors in the past year. These legal issues are not only costly to settle, but could also have other ramifications. Among those that have experienced pay-related litigation, nearly half of the organizations (44%) had to cut employee headcount following these issues.

Tips and best practices for payroll compliance

1. Create a payroll compliance checklist

   A payroll compliance checklist is a tool that outlines the specific requirements and obligations related to payroll compliance. It serves as a comprehensive guide and helps businesses adhere to all applicable laws and regulations. The checklist may include items such as tax filing deadlines, minimum wage requirements, overtime regulations, employee classification guidelines, and record-keeping obligations.

2. Perform regular payroll audits

   A payroll audit is a periodic review of a company’s payroll processes and records to verify that it is paying employees accurately, timely, and in compliance with the law. By conducting regular audits, businesses can proactively address compliance gaps, rectify mistakes, and implement corrective measures to ensure ongoing compliance.

3. Utilize dedicated payroll software

   Payroll software automates various payroll tasks, such as calculating wages, deductions, and tax withholdings. By using dedicated payroll software, businesses can streamline their payroll management processes, minimize errors, ensure accurate calculations, and facilitate compliance with relevant laws and regulations.

4. Carefully review employee classifications

   Employee classification is essential for determining the proper application of labor laws, including wage rates, overtime eligibility, and benefits. Misclassifying employees, such as incorrectly categorizing them as independent contractors, can lead to non-compliance and potential legal consequences. Regularly reviewing and confirming employee classifications helps mitigate this risk.

5. Implement a reliable time and attendance system

   Effectively tracking employee hours is crucial for compliance with wage and hour laws. A reliable time and attendance system helps track employee work hours accurately, assists in maintaining records for auditing purposes, and addresses any discrepancies or issues promptly.

6. Meet deadlines for submitting tax withholdings

   Employers should stay on top of specific deadlines for submitting federal, state, and local payroll taxes. This ensures payroll taxes are withheld and remitted on time and in compliance with tax regulations, helping to avoid any penalties or interest charges.

How to employ compliantly?

Set up a local legal entity in the foreign country where you intend to hire.

This option provides the highest level of control and allows you to directly employ and manage your workforce. However, it can be complex and time-consuming; you’ll need to decide what type of entity to set up, open a local bank account, register a physical office (in some countries), and gain expertise in local laws, tax regulations, and employment obligations in each location.

Employing via an Employer of Record (EoR)

An EoR is a third-party service provider that serves as the legal employer of your overseas workers. By partnering with an EOR, you can leverage their infrastructure and expertise to handle employment contracts, payroll processing, benefits administration, and compliance with local labor laws. This option enables you to expand your global workforce quickly and navigate local employment regulations more efficiently.

Finding a trustworthy EoR in each location can be time-consuming. That’s why more and more enterprises prefer to work with an EoR aggregator, like Papaya Global, that has long-standing relationships with reliable in-country partners across the globe.

Working with independent contractors

An independent contractor is a self-employed individual hired to provide specific services as a non-employee. Engaging contractors can be a flexible and cost-effective option for global employment.

However, it’s crucial to ensure compliance with local laws and regulations regarding the proper classification of workers as independent contractors. Misclassification can lead to legal and financial issues, so it’s essential to carefully evaluate the nature of the relationship and local regulations.

Is there any new legislation regarding remote work?

Yes. Deloitte’s latest International Employment Law Guide, which covers employment law rules on hiring and dismissal in 64 countries, revealed that many jurisdictions introduced new legislation to regulate remote work following the COVID-19 pandemic. In other countries, legislative discussions regarding remote work are still ongoing.

In countries where remote working legislation already exists, employers must draft an addendum to each employment agreement that clarifies the rights and obligations of the employee regarding remote work. In addition, employers have to cover at least part of the expenses that stem from working remotely.

Is there any legislation regarding equal pay?

Yes. The European Parliament recently adopted a legislative proposal on pay transparency measures that will require EU companies to disclose information that makes it easier for employees to compare salaries and expose existing gender pay gaps.

Under the new rules, pay levels must be based on gender-neutral criteria and include gender-neutral job evaluation and classification systems. The rules also stipulate that workers are entitled to receive information on individual and average pay levels, broken down by gender.

Member states will have to put in place penalties, such as fines and sanctions, for employers that don’t comply with the rules. And for the first time, the rights of non-binary people have been included in the scope of the new rules.

Is there any legislation regarding termination?

According to Deloitte’s International Employment Law Guide, countries in all regions often recognize several concepts concerning termination. For example, in many jurisdictions, dismissal with reason is only possible when based on reasons stipulated by law.

Other prevalent termination-related concepts include protection against dismissal for certain categories of employees (e.g., maternity, sickness, political mandate, etc.); a notice period that can be replaced by a one-off remuneration (payment in lieu of notice), or a type of garden leave; and specific procedure for mass termination.

How can companies provide equity to employees in different countries?

Equity plans are regulated by tax laws, security procedures, and accounting principles, which differ from country to country. Without consulting with tax experts and legal advisors, companies that parcel out equity to employees in different locations face a major compliance risk.

Another option is to outsource your payroll operation to a service provider whose offering includes an equity solution, like Papaya Global. From designing your global equity plans based on each individual’s employment model to taking care of disclosures and other filing obligations to calculating tax rates – Papaya’s in-house equity experts can administer the whole process while ensuring compliance.

Why is payroll compliance important?

At its most basic level, payroll compliance ensures that employees are compensated correctly for their work. This is becoming increasingly challenging for companies with a global workforce – whether they choose to open local legal entities, employ via an EoR, or hire independent contractors – as each country’s legal framework is different, which explains why many enterprises turn to payroll providers with compliance expertise, like Papaya Global.

Complying with payroll legislation can also help businesses in other areas. Among other things, payroll compliance legislation helps improve workforce morale, maintain employee trust, uphold the company’s reputation, streamline operations, and avoid financial penalties and costly litigation.

Get peace of mind for all things compliance

At Papaya Global, the world’s leading payroll and payments platform, we pride ourselves on introducing a new standard for compliance. Papaya’s core offering includes access to in-house experts on every compliance aspect, mitigating the risks of managing a global workforce, and allowing companies to focus on growing their business. Schedule a demo to learn more.