The 8-Step Payroll Compliance Audit Every Founder Should Run

As a founder, you're focused more on growth, product, and culture. But one area that can harm your startup and employee experience is mismanaged payroll. Payroll goes beyond just issuing timely paychecks, and even minor mistakes can result in frustrated employees and expensive penalties.

Many small businesses struggle to keep up with evolving HR regulations. Yet you don’t need to be an HR expert to protect your business. A proactive quarterly payroll audit can help you. Think of it as a routine health check to ensure compliance, avoid penalties, and boost employee satisfaction. 

Here is an 8-step audit every founder should run to ensure their HR payroll compliance is foolproof.

Step 1: Reconcile Your Master Employee List

First, pull a master list of every employee paid during the quarter from your payroll system. This could be an HRMS or a set of manual entries.

Does it match your list of active employees? Ensure that employees who left the company during the quarter are correctly marked and excluded from active payroll.

Step 2: Verify Worker Classifications

Verify whether your workers are classified as employees, contractors, or part-time workers. Misclassifying employees as independent contractors is one of the most common and costly compliance mistakes a small business can make.

Double-check that your W-2 employees and 1099 contractors are classified correctly according to IRS and Department of Labor guidelines. You must ensure the classifications are accurately mapped to calculations in your HRMS. 

Step 3: Audit Employee Data and Withholdings

Go through your active employee roster. Are names and addresses correct? Most importantly, have you received and correctly entered the information from each employee’s W-4 for tax withholdings?

Be mindful of laws in different states where your workers operate to calculate withholdings accurately. 

Step 4: Review Wages, Hours, and Overtime

Spot-check the records of your non-exempt (hourly) employees. Were all hours recorded accurately? Was overtime calculated correctly based on federal and specific state laws? 

Typically, an HRMS software automates this, but you must manually verify wages to ensure accuracy.

Step 5: Check Leave Balances and Deductions

Review the PTO and sick leave balances for a few employees. Do the accruals and deductions for time taken look correct? Also, verify that deductions for benefits like health insurance or retirement contributions were made accurately.

Step 6: Reconcile Payroll Registers With Bank Records

This step confirms that the money went to the right place. Match the payroll debit amounts from your company bank account for each pay period to the totals on your payroll registers. This simple reconciliation can quickly identify significant processing errors or even potential fraud.

Step 7: Confirm Tax Payments and Filings

Did you pay your payroll taxes on time? Verify that all federal, state, and local payroll tax deposits for the quarter were made by their deadlines. 

Step 8: Review Your System's Access and Security

Finally, review who has administrative access to your HRMS and payroll data. Check audit trails to ascertain whether systematic decision-making was followed. Remove permissions for any former employees or managers who no longer need them.

Limiting access is a critical security step to protect sensitive employee data and prevent unauthorized changes. Ensure your employees have self-serve options.

Rely on Experts to Boost Compliance

Running a quarterly audit is a crucial defensive move. But in the end, it’s you, the founder, who has to run it, spending valuable hours on tasks that experts can handle. 

DianaHR can manage your entire payroll and compliance so you can stay worry-free and focus on your business. As your fractional HR department, our experts handle everything from employee onboarding and state registrations to complex payroll management and compliance. They can help you boost payroll compliance and run audits periodically. 

Get HR expert support to boost compliance. Chat with DianaHR today. 

FAQs

1. What is a payroll audit?

A payroll audit is a routine business process where a company reviews its payroll records and processes to confirm accuracy and compliance. The goal is to verify that employees are being paid the correct salary, that all deductions and tax withholdings are managed accurately, and that the company is adhering to employment laws and regulations. 

1. What are the important steps in a payroll audit?

The important steps in a payroll audit involve a review of your entire process, from individual employee records to overall financial reconciliation. Key actions include verifying that all employee data, such as names, salaries, and tax information, is accurate. You must also ensure the accuracy of pay rates and overtime calculations, check that paid time off (PTO) has been entered correctly, and reconcile your payroll reports against bank statements.

2. Do you need to be an expert to run a payroll audit?

While you don't necessarily have to be a certified expert, running a thorough payroll audit can be daunting, especially for founders or managers handling it for the first time. Many small companies lack the dedicated teams needed to manage payroll or audits. For this reason, onboarding an HRMS software or partnering with outsourced experts helps. They ensure audits are comprehensive and accurate, allowing founders to focus on growing their businesses.