Overview

Payroll compliance means paying people accurately and on time while meeting every wage, tax, reporting, and privacy rule that applies to your workforce.

For 2025–2026, the bar is higher. You’ll face multi-state and local taxes, stricter state pay rules, evolving exempt thresholds, privacy obligations, fringe and equity taxation, and tight IRS deposit schedules. This guide gives HR/payroll managers, controllers, and finance leaders a practical, statute‑anchored playbook to run compliant payroll at scale.

What you’ll get: plain‑English definitions anchored to federal and state rules, worked calculations (FLSA regular rate, garnishments), a deposit schedule and lookback workflow, error-correction steps (941‑X/W‑2c), and decision frameworks (in‑house vs outsourcing vs PEO vs EOR).

Use it to build your 2025 payroll calendar, strengthen internal controls, and reduce audit and penalty risk across jurisdictions.

What payroll compliance means and why it matters

Payroll compliance is the discipline of calculating, withholding, depositing, and reporting wages and taxes correctly. It includes honoring wage/hour and garnishment laws, protecting payroll data, and keeping the right records.

At its core are the Fair Labor Standards Act (FLSA), federal and state income tax rules, FICA and FUTA, state unemployment insurance (SUTA), and state/local overlays. Errors cascade—misclassifications create back overtime, wrong deposit schedules trigger IRS penalties, and missed city taxes lead to local assessments.

Two facts to keep you oriented: the federal minimum wage is $7.25/hour and overtime is due at 1.5× the regular rate under the FLSA, with stricter state rules controlling where they exist. The IRS imposes late-deposit penalties ranging from 2% to 15% depending on how late the payment is, and a “$100,000 next‑day rule” that accelerates deposits when liabilities spike.

Ground your process in the primary sources. Use the FLSA via the U.S. Department of Labor and federal employment tax rules in IRS Circular E.

Definition and scope

Operationally, payroll compliance spans five domains: wage/hour rules (minimum wage, overtime, regular rate, exempt vs nonexempt); tax calculation, withholding, and deposits (FIT, FICA, FUTA, SUTA, local taxes); statutory orders (child support, tax levies, creditor garnishments); reporting and filings (941/940, W‑2/W‑3, state returns, 1095‑C); and records and privacy (FLSA/IRS retention, CCPA/CPRA, GDPR).

Benefits that flow through payroll—fringe benefits and equity—raise imputed income, withholding, and reporting requirements. The scope stops short of plan administration or corporate income tax, but payroll must integrate with HR, benefits, and accounting to stay compliant.

A practical example: a California nonexempt employee working some days in Oregon triggers wage/hour rules for each workweek, state withholding and SUTA registration, and possible Oregon local transit taxes. FLSA overtime calculations must include shift differentials and nondiscretionary bonuses.

The action item is to map each employee’s “jurisdiction stack” (resident state, work state(s), local taxes) and build the payroll configuration to match.

Common failure points and penalty exposure

Most findings trace to a few predictable gaps: misclassifying employees as exempt without meeting duties/salary tests; miscalculating the FLSA regular rate by excluding nondiscretionary bonuses/commissions; applying the wrong IRS deposit schedule; ignoring city wage tax registrations; and mishandling garnishment priorities.

The IRS’s $100,000 next‑day deposit trigger and late-deposit penalties (2%–15%) catch many employers during bonus cycles. DOL audits frequently recover back wages for regular‑rate errors and off‑the‑clock work.

Consider a quarterly production bonus paid to nonexempt staff. If you don’t allocate it back to each overtime week to increase the regular rate, you owe additional overtime. If that same bonus pushes your FICA/FIT deposit above $100,000 in a single day, you must deposit by the next business day or face higher penalties.

Build preventive checks around bonus cycles, and anchor your deposit cadence to IRS Circular E.

Role clarity across HR, payroll, and finance

Split responsibilities to reduce control gaps. HR owns classification, wage notices, and timekeeping policy. Payroll owns calculations, tax setup, garnishments, and filings. Finance owns cash funding, bank authorizations, reconciliations, and internal controls.

In practice, that means HR validates job duties against exemption tests. Payroll calculates the regular rate and sets deposit schedules. Finance reviews EFTPS authorizations and performs 941‑to‑GL tie‑outs.

Define backups for each critical task and schedule quarterly cross‑checks to catch misconfigurations early.

Federal payroll laws and tax frameworks you must master

Federal rules set the baseline. State and local laws can be stricter but not less protective, so start with the FLSA and federal tax mechanics, then overlay state specifics.

Mastery of FIT/FICA/FUTA calculations and IRS deposit rules prevents the most costly mistakes. You’ll avoid late deposits, incorrect withholding, and miscalculated overtime.

FLSA minimum wage and overtime

The FLSA requires at least $7.25/hour and overtime of 1.5× the regular rate for hours over 40 in a workweek, unless an exemption applies. States and cities often mandate higher minimums, daily overtime (e.g., some jurisdictions), or stricter off‑the‑clock rules. The stricter rule controls.

The “regular rate” includes most nondiscretionary pay like production bonuses, commissions, shift differentials, and certain stipends. It excludes discretionary bonuses, true expense reimbursements, and gifts.

Example: An employee works 48 hours at $18/hour and earns a $96 weekly shift premium. Total straight‑time pay is 48×$18 = $864; add the $96 premium = $960. Regular rate = $960 ÷ 48 = $20. Overtime premium due = 8 hours × 0.5 × $20 = $80. Document your regular‑rate method and reference the DOL’s FLSA framework at U.S. Department of Labor — FLSA.

FIT, FICA, FUTA: withholding and wage bases

Federal income tax (FIT) is withheld using Form W‑4 and the methods in Pub. 15‑T. FICA includes Social Security (6.2% each employee and employer, up to the annual wage base) and Medicare (1.45% each, with an extra 0.9% Additional Medicare Tax employee‑only over the threshold).

FUTA is an employer tax with an annual wage base and potential state credit reductions. It’s reported on Form 940. State unemployment (SUTA) is separate and determined by each state’s experience rating and wage base.

Example: On a $2,500 biweekly paycheck, FICA‑SS is $155 (6.2%). Medicare is $36.25 (1.45%). FIT depends on the employee’s W‑4. Supplemental wages (bonuses) are generally subject to the federal flat supplemental rate unless aggregated. Confirm current rates and wage bases in IRS Circular E and Pub. 15‑T before each year.

Deposit schedules and the IRS lookback period

Your payroll tax deposit schedule (monthly vs semiweekly) is driven by a “lookback period” total of employment taxes. Generally, if your total reported on Forms 941 during the lookback period is $50,000 or less, you’re a monthly depositor. More than $50,000 makes you semiweekly.

Any employer that accumulates $100,000 or more in employment taxes on any day must deposit the next business day. Small quarterly liabilities (e.g., $2,500 or less) may be paid with the return. See IRS Publication 15 (Circular E) for the exact rules and lookback dates.

To determine your 2025 schedule, total your 941 liabilities for the lookback period defined in Circular E and assign your cadence. Then layer on the next‑day rule around bonus dates and quarter‑end accruals.

Schedule EFTPS payments ahead of time and align payroll funding to the deposit due dates.

Backup withholding and B‑notice handling

Backup withholding applies at a flat 24% when required under IRC §3406. This typically occurs when a payee fails to furnish a taxpayer identification number (TIN), the IRS notifies you of a name/TIN mismatch, or there’s underreporting.

When you receive a CP2100/CP2100A notice (a “B‑notice”), you must follow prescribed steps. Notify the payee, solicit a new Form W‑9, and for certain repeat mismatches obtain IRS/SSA validation. Withhold at 24% until documentation cures the issue and report the withholding on information returns.

Follow the timelines and documentation in IRS Publication 1281. Keep a log of solicitations and responses.

Record retention basics (federal)

Keep FLSA payroll records (pay rates, hours, additions/deductions) at least three years. Keep supporting timecards and work schedules at least two years.

Retain employment tax records (returns, deposit proofs, W‑4s, fringe/equity calculations) at least four years after the tax becomes due or is paid. Form I‑9s must be retained for three years after the date of hire or one year after termination, whichever is later.

Electronic records are acceptable if they are accurate, accessible, and safeguarded against alteration. Align formats with your HRIS and audit procedures.

Multi-state and local payroll compliance for remote and mobile workers

Remote work made payroll jurisdictional rules front‑and‑center. Employees usually owe tax to the state where they work, but residency, reciprocity, and local wage taxes can change withholding requirements.

Employers must register to withhold in work states that have income tax. They must coordinate SUTA to a single primary state and allocate wages correctly for employees who travel across states.

Tax nexus and reciprocity agreements

A single remote employee working in a state generally creates withholding and unemployment registration obligations in that state. Reciprocity agreements between certain states allow employers to withhold only the employee’s resident‑state income tax if the employee files the proper certificate.

Common reciprocity pairs include PA–NJ, VA–MD–DC, IL–IN, MI–OH, and AZ–many neighbors.

Example: A Pennsylvania resident working remotely for a New Jersey employer can rely on PA–NJ reciprocity. The employer withholds PA income tax only, provided the employee files the state‑specific nonresident certificate.

Track employee resident addresses, obtain reciprocity certificates at hire, and update configurations promptly upon address or work‑location changes.

Local wage taxes and city filings

Several cities and localities impose their own income or earnings taxes with separate registrations and returns. Hot spots include Philadelphia’s Wage Tax, numerous Ohio municipalities (via RITA/Central Collection Agency systems), many Michigan cities (e.g., Detroit), and Missouri’s St. Louis and Kansas City earnings taxes.

Some jurisdictions also impose local services or transit taxes. Employers must register with the local agency, withhold the local tax based on residence or work location as required, and file local returns on the prescribed schedule.

Operationally, add a “local tax check” to onboarding for addresses in Pennsylvania, Ohio, Michigan, and Missouri. Build an annual reconciliation step to confirm local returns tie to state wages and your general ledger.

Mobile employee wage allocation and SUTA coordination

When employees work in multiple states during a workweek, allocate taxable wages to each state based on your policy (e.g., days or hours in each state) and the state’s sourcing rules.

For unemployment (SUTA), apply the localization/base-of-operations/place-of-direction-and-control test to determine a single state for all wages. If work is localized in one state, pay SUTA there. If not, look to the employee’s base of operations. If none, look to the place of direction and control, and finally to the employee’s residence.

Example: A field engineer lives in Colorado, reports to a supervisor in Texas (where tools and dispatch originate), and works weekly in New Mexico and Arizona. If no state meets “localized,” SUTA likely follows the base of operations (Texas) or place of direction/control (Texas).

Document the test outcome and keep it with your SUTA account files.

New hire reporting across states

All employers must report new hires within a set timeframe (typically 20 days). Multi‑state employers may choose a single state to which they report all hires, but they must notify the federal Office of Child Support Enforcement (OCSE) of that selection and file electronically.

Align your onboarding workflow to capture required data (legal name, address, SSN, work site) and submit within the deadline via the state portal or the multi‑state employer program described by OCSE — New Hire Reporting.

State pay rules: pay frequency, paystubs, final wages, and PTO payout

State wage payment laws diverge in meaningful ways. You must adopt a payroll calendar that meets each state’s pay frequency rules, issue compliant wage statements, and pay final wages promptly.

Many states also regulate whether and when unused PTO must be paid.

Pay frequency and payroll calendar requirements

States set minimum pay frequencies—weekly, biweekly, semimonthly, or monthly—sometimes by worker type. For example, “manual workers” in New York generally must be paid weekly.

Some states require specific payment windows, such as within a set number of days after the pay period. If you run a national payroll, design a unified cadence that satisfies the strictest state your employees work in. Clarify in your handbook when paydays shift for holidays.

Example: A multistate employer with staff in New York and Texas may opt for biweekly payroll. You must confirm that all New York “manual workers” receive pay weekly or secure any permissible designation. Build state‑specific variants where one cadence won’t suffice.

Paystub content and wage notice rules

Several states prescribe paystub content—gross/net pay, hours by rate, pay period dates, legal entity name, address, and year‑to‑date totals. California’s Labor Code 226 is exacting.

New York’s Wage Theft Prevention Act requires wage notices at hire and upon certain changes. Missing fields or inaccurate paystubs are common penalty drivers.

Implement a standard template that includes all common statutory fields. Run quarterly audits against state checklists. For New York hires, attach the wage notice to your offer package and store signed acknowledgments with payroll records.

Final pay timing and unused PTO payout

Final pay deadlines vary by state and by separation type. Some states require immediate payment at termination; others allow a set number of days.

States also treat PTO differently. Some mandate payout of earned PTO, others allow policy control, and a few prohibit “use‑it‑or‑lose‑it” forfeitures.

Operationalize final pay by state and scenario. Create a “termination day checklist” with payment timing, delivery method (check vs direct deposit), and whether to include accrued PTO. Configure your HRIS to calculate PTO payout per state rules and your written policy.

Predictive scheduling and reporting-time pay

“Reporting time pay” and “predictive scheduling” rules add costs when schedules change late. California requires partial pay when employees are required to report but aren’t put to work. New York and Massachusetts have similar “show‑up” rules.

Predictive scheduling laws in places like Oregon (statewide), Chicago, New York City, and Seattle require advance schedule notice and premium pay for last‑minute changes in covered industries.

Audit your scheduling practices in retail, food service, hospitality, and healthcare. Pair timekeeping with scheduling software that flags premium pay triggers. Train managers not to adjust timecards to avoid owed premiums.

Calculating the FLSA regular rate and special pay scenarios

Most wage/hour liabilities stem from regular‑rate mistakes. The regular rate is all remuneration for employment divided by total hours in the workweek, with specific exclusions.

Get the formula right for bonuses, commissions, tips, and differentials. Do that and you eliminate the bulk of overtime risk.

Regular rate formula with bonuses and commissions

The rule: include nondiscretionary bonuses and commissions in the regular rate and allocate them to the workweeks they cover. Exclude discretionary bonuses (not promised or expected), true reimbursements, gifts, and vacation/PTO payouts.

Worked example (quarterly bonus):

Action: Build a process to (1) pro‑rate bonuses/commissions to covered workweeks, (2) recalc overtime premiums for those weeks, and (3) pay “true‑up” overtime with the bonus.

Tips, service charges, and tip credits

Under federal law, employers may take a “tip credit” toward minimum wage for tipped employees if strict conditions are met. The cash wage can be as low as $2.13/hour federally, with a $5.12 tip credit to reach $7.25. Many states prohibit or limit the tip credit.

For overtime, compute the regular rate based on the full minimum wage (or higher state minimum), not the lower cash wage. Include service charges distributed to employees as wages.

Example: If your jurisdiction allows a $3.00 tip credit and the state minimum is $15, the cash wage is $12. For 50 hours, regular rate must reflect at least $15 and actual earnings with tips. Overtime premium equals 10 × 0.5 × the regular rate.

Keep written tip credit notices and proof that employees retain all tips except for lawful pools.

Shift differentials, training, travel, and on‑call time

Shift differentials and most mandatory training time are hours worked and belong in the regular rate. Travel during the normal workday is compensable; home‑to‑work commuting is generally not.

On‑call time is compensable when employees are so restricted they cannot use the time for their own purposes.

Example: A night shift differential of $1.50/hour paid for 40 hours adds $60 to the week’s remuneration and increases the regular rate used to compute the overtime premium. Document your compensable time rules, train supervisors on travel and training pay, and audit high‑risk departments quarterly.

Tipped employees: tip pooling and notice

If you claim a tip credit, the pool may include only employees who customarily and regularly receive tips. If you do not claim a tip credit and pay at least full minimum wage in cash, a broader pool may include back‑of‑house under federal rules.

Service charges (mandatory fees on bills) are not tips. They are wages to employees when distributed and must be included in the regular rate.

Provide written notices describing any tip credit and pooling rules. Keep acknowledgments with payroll records.

Exempt vs nonexempt: salary thresholds and duties tests

Exempt status depends on both duties and salary thresholds under federal and state law. If you miss either test, the employee is nonexempt and overtime applies.

Because several states set higher thresholds or different duties tests, you must evaluate jurisdiction by jurisdiction.

Federal and state thresholds

Under federal rules, white‑collar exemptions require paying on a salary basis at or above the federal threshold and meeting the appropriate duties test (executive, administrative, professional).

Several states—such as California, Washington, and New York—impose higher minimum salaries or different standards. When thresholds change midyear, you must adjust salaries or reclassify employees accordingly.

Action: Maintain a jurisdictional matrix of thresholds. Review salaries quarterly against the highest applicable threshold for employees working across states.

Highly compensated and computer exemptions

The highly compensated exemption relaxes the duties analysis for employees earning total annual compensation above a specified amount and meeting minimal office or non‑manual duties.

Computer employee exemptions allow hourly or salaried treatment if duties and pay thresholds are met. Titles alone don’t control.

Common pitfalls include misusing the computer exemption for help desk roles and paying impermissible deductions that break the salary basis. Audit duties against the regulatory text, not job titles, and keep contemporaneous job descriptions and manager attestations on file.

Misclassification risks and audits

Misclassifying nonexempt employees as exempt creates back overtime, liquidated damages, taxes, and penalties, plus potential class claims. Regulators often request time and pay records, job descriptions, and organizational charts.

If you discover misclassification, consult with counsel on remediation options. Consider prospective reclassifications, back pay calculations, and communication planning. Implement controls to prevent recurrence (e.g., classification check at requisition and offer stages).

Child labor and youth wage restrictions

The FLSA limits the hours and types of work 14–15‑year‑olds may perform and restricts hazardous occupations for minors. A lower “youth minimum wage” may apply for the first 90 consecutive calendar days of employment for eligible workers, but many states are stricter.

Confirm allowable hours during school weeks, breaks, and permitted tasks by age. Configure your scheduling system to block prohibited assignments.

Payroll calendars, deposit schedules, and internal controls

Turning rules into routine is how you stay compliant. Build an annual calendar, lock down your IRS deposit cadence, and operate a control environment with clear segregation of duties.

Pair that with privacy-by-design and robust record retention. You’ll be audit‑ready.

Annual deadline calendar and EFTPS

Anchor your year with recurring federal due dates. Forms 941 are due by the last day of the month following each quarter end (April 30, July 31, October 31, and January 31). Form 940 is due by January 31. Forms W‑2 are due to the SSA and to employees by January 31.

Fit state withholding and SUTA returns into the same calendar. Mark bank holidays that shift EFTPS processing.

For deposits, monthly depositors remit by the 15th of the following month. Semiweekly depositors remit by the Wednesday or Friday following payday based on the day wages are paid, with next‑day deposits any time liabilities hit $100,000.

Schedule EFTPS payments in advance. Verify authorizations for backup approvers. Reconcile deposits to payroll registers weekly.

Segregation of duties and payroll controls

Core payroll controls reduce error and fraud:

Open and close each quarter with a checklist. Hold a post‑mortem for any defects or late deposits to drive corrective action.

Data privacy: CCPA/CPRA and GDPR

Employer “employee data” is now fully in scope under California’s CPRA. You must provide notice at collection, support data‑subject rights workflows (access, correction, deletion as applicable), maintain reasonable security, and include required clauses in vendor contracts.

If you process EU resident data, GDPR requires a lawful basis (often legal obligation or contract), transparency, data minimization, and cross‑border transfer safeguards. Map payroll data flows end‑to‑end. Maintain your retention schedule and test DSAR response processes.

Monitor CPRA rulemaking and guidance through official channels.

Record retention timelines (state overlays)

Keep a single retention policy that meets FLSA and IRS baselines and overlays stricter states. Some states require six years of wage records.

California requires three years for payroll records and longer for certain personnel documents. Store I‑9s separately from personnel files, restrict access to SSNs and bank data, and maintain an auditable destruction log once retention periods end.

Garnishments and orders: priority and safe withholding

Garnishments are court or agency orders that require you to withhold and remit portions of an employee’s pay. Getting priority, limits, and remittance right protects the employee and the company.

The federal Consumer Credit Protection Act (CCPA) caps garnishments. Special rules apply to child support and tax levies.

Child support, tax levies, and creditor orders

Priority is generally: child support (and alimony) first, then federal tax levies (depending on timing), then state tax levies, then creditor garnishments.

For child support, you must begin withholding promptly upon receipt and remit to the state disbursement unit. For federal tax levies, use the employee’s exemptions to compute protected amounts and remit the balance until the IRS releases the levy.

Creditor garnishments are subject to CCPA limits and state rules. Establish a garnishment intake process to validate orders, set priority, compute disposable earnings, apply the correct cap, and remit on schedule.

Keep correspondence, calculations, and remittances in a dedicated case file.

Federal and key state percentage limits

Under the CCPA, the maximum weekly garnishment for most creditor debts is the lesser of 25% of disposable earnings or the amount by which disposable earnings exceed 30× the federal minimum wage.

For child support, federal limits allow up to 50%–60% of disposable earnings (plus 5% if more than 12 weeks in arrears), depending on whether the employee supports another family. Use agency worksheets and, for tax levies, the IRS tables that determine exempt amounts.

Confirm caps and federal rules in DOL Fact Sheet #30 — CCPA Garnishment.

Example: Disposable earnings of $700/week. Creditor garnishment cap is the lesser of $175 (25%) or $700 − (30×$7.25 = $217.50) = $482.50, so the cap is $175. If a child support order for 50% is also in place, child support withholds up to $350 and leaves no room for a creditor garnishment that day.

Multi-order conflicts and employer liability

When multiple orders compete, apply priority and caps, document shortfalls, and notify lower‑priority creditors when there isn’t sufficient disposable income. Never exceed the highest applicable cap.

Failing to honor an order can make the employer liable for amounts not withheld, plus penalties. Keep a “garnishment ledger” per employee that shows order dates, priority, calculations, and remittances. Revisit calculations upon pay changes or new orders.

Fringe benefits, expense reimbursements, and equity compensation

Fringe benefits and equity awards often create imputed income, additional withholding, and special W‑2 reporting. Most errors stem from misclassifying taxable benefits, missing year‑end imputations (e.g., company car personal use), or mishandling equity withholding at vest/exercise.

Imputed income and W‑2 reporting

Common taxable fringes include the cost of group‑term life insurance over $50,000, personal use of company cars, certain awards/prizes, and most moving expense reimbursements (except limited military moves). You must determine the taxable value, add it to wages for FIT/FICA/Medicare, and report correctly on the W‑2.

For example, group‑term life over $50,000 is reported using IRS Table I methods and shown in Box 12 with Code C. The total cost of employer‑sponsored health coverage (informational) is Box 12 Code DD. For rules and valuation methods, use IRS Publication 15‑B (Fringe Benefits).

Close your year with a fringe imputation checklist: cars, GTL, awards, relocation, and de minimis benefits thresholds.

Accountable plans for reimbursements

An accountable plan allows business expense reimbursements to be excluded from wages if three conditions are met: business connection, timely substantiation, and timely return of excess advances.

If these are not met, reimbursements are taxable wages. Document your plan under Treas. Reg. §1.62‑2. Require receipts and business purpose within your set timeframe. Reconcile card programs monthly so personal or unsubstantiated charges are added to wages promptly.

Equity awards: RSUs, ISOs, and NSOs taxation

Coordinate with your equity administrator to ensure shares or cash are withheld to cover taxes. Confirm payroll journals capture the wage component. Ensure W‑2 boxes/codes are correct per IRS fringe benefit guidance.

Company cars, GTL, awards, and moving expenses

Choose a valuation method for personal use of employer‑provided vehicles (annual lease value, commuting, or cents‑per‑mile where allowed). Impute at least annually.

Add the GTL over‑$50,000 cost to wages each pay period or at year‑end. Cash awards and most gift cards are taxable; length‑of‑service awards may qualify for limited exclusions if policy and limits are met. Post‑TCJA, most employer‑paid moving expenses are taxable wages.

Create a quarterly “fringe review” with accounting to capture taxable events as they occur, not just at year‑end.

Special populations and programs: nonresident aliens, third‑party sick pay, and ACA reporting

Certain populations and programs require specialized withholding, reporting, and coordination. Build targeted workflows so these cases don’t derail your year‑end.

Nonresident alien payroll and tax treaties

Determine tax residency using the substantial presence test or green card test. Nonresident aliens must typically use special Form W‑4 instructions (e.g., required status entries).

Certain treaty benefits can exempt wages (in whole or part) from FIT if the employee files the right forms (e.g., Form 8233) and you approve. Treaty‑exempt wages are generally reported on Form 1042‑S, and otherwise taxable wages go on Form W‑2. FICA exemptions may apply to some visa categories.

Action: Maintain a checklist for onboarding NRAs. Capture visa type, residency determination, W‑4 NRA instructions, treaty analysis, and 1042/1042‑S controls. Revisit residency annually.

Third‑party sick pay coordination

When an insurance carrier pays short‑ or long‑term disability, you must coordinate who withholds/remits FICA, who issues the W‑2 (employer vs insurer vs third‑party), and how to allocate taxable vs nontaxable portions.

If the employer pays the premiums pre‑tax, sick pay may be taxable. If employees pay post‑tax, benefits may be nontaxable. Exchange quarterly wage/tax data with the carrier and true‑up at year‑end so W‑2 boxes reflect correct sick pay and FICA.

ACA employer mandate and 1094/1095‑C

Applicable Large Employers (ALEs) with 50+ full‑time employees (including FTE equivalents) must offer affordable, minimum‑value coverage to full‑time employees and their dependents or face potential §4980H penalties.

You must furnish Form 1095‑C to employees and file 1094‑C/1095‑C with the IRS on deadline. Align measurement/stability periods with payroll hours, track dependents and coverage offers, and reconcile your HRIS to forms and codes. See the IRS’s ALE guidance at IRS — ACA Information Center for ALEs.

Error correction and year-end reconciliation

Even strong processes need corrections. What matters is speed, documentation, and using the right correction paths.

Tackle discrepancies quarterly, not just in January.

Quarterly vs annual tie‑outs

Reconcile each quarter: payroll registers to cash funded; 941 lines to gross wages, taxable wages, and taxes; and cumulative payroll to the general ledger.

Investigate variances like rounding, third‑party sick pay, prior‑period adjustments, and voids. In Q4, tie year‑to‑date totals to W‑2 previews, verify fringe imputations and equity wage adds, and confirm state/local wage alignment.

Maintain a reconciliation binder with screenshots, reports, and sign‑offs. This cuts year‑end scramble and supports audit readiness.

Form 941‑X and W‑2c workflows

Use Form 941‑X to correct under‑ or over‑reported federal employment taxes for a prior quarter. Choose “adjusted return” vs “claim” appropriately and attach explanations and calculations.

For W‑2 errors (name/TIN, wages/taxes), file W‑2c/W‑3c and furnish copies to employees. If a prior error changes both 941 and W‑2 amounts, fix the 941 first, then issue W‑2c.

Follow the steps and timing in IRS Instructions for Form 941‑X. A practical sequence: identify the root cause; quantify by quarter; prepare 941‑X with supporting schedules; post GL adjustments; file W‑2c; and monitor notices.

Penalty abatement and reasonable cause letters

If you incur a late‑filing or late‑deposit penalty, evaluate First‑Time Abate eligibility and reasonable cause. A strong reasonable cause letter explains the facts, the law, and the actions you took to comply.

Describe what went wrong (e.g., natural disaster, software failure outside your control) and the corrective steps you implemented. Attach evidence—EFTPS confirmations, vendor tickets, and control changes. Track all correspondence and deadlines.

Build a “penalty response kit” template so you can respond within 30 days and avoid escalations.

Build vs buy: in-house, outsourced, PEO, or EOR

Your operating model determines who holds compliance risk, who executes controls, and how you scale. Evaluate through three lenses: liability, total cost, and control.

Compliance liability and risk transfer

Read contracts closely: who signs returns, who owns correction workflows, and who indemnifies whom for penalties.

Total cost of ownership and ROI

Model beyond per‑employee fees. Include internal staffing, time spent on corrections, penalties avoided, integrations, implementation, and the opportunity cost of delayed closes.

For high‑complexity payrolls (multi‑state, lots of locals and garnishments), automation and managed services often deliver ROI via fewer errors and faster closes. For stable single‑state payrolls, an in‑house model with strong controls may be most cost‑effective.

Quantify error rates, deposit penalty incidents, and cycle times today. Use them to benchmark improvement and justify investment.

RFP criteria and due diligence (SOC 1 Type II)

When vetting vendors, require:

Request sample calendars, filing proofs, and a notice‑to‑resolution playbook before you sign.

2025–2026 payroll regulatory watchlist

Use this forward look to plan budgets, update policies, and brief leadership. Refresh it quarterly—thresholds and effective dates evolve.

Exempt salary threshold updates

Watch for federal adjustments to the white‑collar salary threshold and parallel litigation. States like California, Washington, and New York commonly update their own thresholds annually or by policy tied to state minimum wages.

Budget for mid‑year salary moves or reclassifications. Communicate early with affected employees and managers.

Pay transparency and leave mandates expansion

More states and cities are adopting pay range disclosure requirements in job postings and expanding paid family and sick leave programs.

Audit your job posting workflows. Ensure ranges are consistent with internal pay policies. Align accrual and payroll systems to new leave accruals, caps, and wage replacement calculations.

Retirement plan limits and SECURE 2.0 changes

IRS retirement plan limits adjust annually for inflation, affecting payroll deferral caps and catch‑ups. SECURE 2.0 phases in features like automatic enrollment for many new 401(k) plans and Roth treatment for certain catch‑ups at higher incomes.

Update payroll deduction limits at year‑start. Confirm catch‑up age and Roth rules in your system. Test provider integrations.

Global expansion and permanent establishment triggers

Hiring abroad can trigger corporate tax “permanent establishment” exposure and local employer obligations, even for a single employee. An Employer of Record (EOR) can help you hire compliantly without forming a local entity, but it doesn’t eliminate all PE risk.

Engage tax counsel early. Map activities to treaty standards. Decide between entity, EOR, or contractor models before hiring.

Disaster relief payments and leave donation programs

Section 139 allows tax‑free qualified disaster relief payments during federally declared disasters. Leave donation programs can route donated PTO value to relief without creating taxable wages for the donor when specific IRS guidance applies.

Keep contemporaneous documentation of the declared disaster, policy terms, and amounts paid. Configure payroll codes to keep qualified payments out of taxable wages while preserving reporting where required.