What you need to know about payroll compliance in the US

The payroll industry in the US exists because the U.S. Government requires employers to withhold taxes from employee wages, and then pay them out to the government on time. This requirement creates a very real administrative burden for employers, and is why they work with payroll providers to help them get it right. For payroll providers, ensuring that their processes and systems are compliant is a huge undertaking. It requires understanding rules across all 50 states and how those states’ rules interact. Misunderstanding these requirements result in penalties, inflated taxation rates, and underpayment of wages. To build a payroll system that is compliant, payroll providers must individually account for each state’s wage, hour, and taxation rules, as well as reporting requirements. 

So how does one even start to think about this level of compliance complexity? You start with the basics: ‘who’, ‘what’, ‘when’, ‘where’, and ‘why’. Payroll compliance teams today use these 5 questions to build an understanding of each state’s tax rules. ‍

1. ‍Who is required to pay the tax? ‍
2. What are the requirements for calculating and remitting the tax?‍
3. When is the tax due? ‍
4. Where is the tax payment/reporting sent?‍
5. Why is the state mandating this tax?

Compliance teams answer these questions for every state tax that is implemented (or may be implemented soon). States traditionally have withholding and unemployment taxes, but they may also have local, disability, paid family leave, and other payroll related taxes. There is no single place to get all of this tax information, so gathering the answers to these questions and applying them to all taxes is both manual and challenging. While paid services can provide updates and explanations on different taxes for different areas, interpretation is left to employers and their payroll providers. This can be especially tricky when it comes to deciding how two state’s rules interact with each other for an individual. If you don’t pay for these services, your compliance team is left to dig through state statutes, administrative rules, employer guides, specifications, and other state publications for the information they need. 

To fully digest why it’s so complicated, let’s walk through Oregon's new Paid Family and Medical Leave Tax (PFML) as an example. 

‍Who is required to pay Oregon’s Paid Family and Medical Leave Tax? 

This new tax applies to ‘employees and employers with 25 or more employees’. While ‘25 employees’ is fairly straightforward, what qualifies someone as an employee or employer? Every state has their own definition of what it means to be an employer or an employee. Therefore, understanding if someone has to pay the tax if they own a brick and mortar store in Oregon, or if a business just has sales or temporary employees in Oregon, is important to knowing if they qualify for the tax. 

What are the requirements for calculating and remitting the tax?

After determining who the tax applies to, understanding ‘the what’ comes next. Oregon requires that the tax is no more than one percent of wages, shared by employers and employees. The tax rate is set annually, so payroll providers need to update the rate each year as needed. 

It gets trickier. Each year, they’ll also need to understand if the tax still applies to the same employees and employers. Remember, Oregon’s PFML is only withheld from  employee wages if the employer has 25 or more employees. Other states may have different thresholds, or none at all. Washington, for example, does not require employers with fewer than 50 employees to contribute to its PFML tax.

When is the tax due? ‍

When does Oregon expect to receive the tax payments? The good news is that states are normally clear on when taxes are due. The bad news is that the due dates vary by state, tax, and tax amounts. For this new PFML tax, Oregon requires the payment to be sent in quarterly, on the last day of the month following the close of the quarter. But, PMFL is not the only tax that applies to Oregon. There’s a withholding tax that has the same due date as federal employment taxes. Then, there’s an unemployment tax that is also due quarterly. Many payroll platforms will have separate tax deposit schedules just to contend with the various rules across states. 

Where is the tax payment/reporting sent?

Where the payment is sent is decided by the tax authority responsible for collecting the tax. Oregon created a new division within its Employment Department to administer and collect its PFML tax. The division then sets up its own tax system that comes with specifications for filing electronically.

Why is the state mandating this tax? 

When building a payroll system, many teams forget about ‘the why’. Why did Oregon introduce this PFML tax? Understanding this helps explain why small businesses are exempt, and what happens if you don’t apply the tax correctly. This can help payroll providers determine the value in supporting the tax and the risk to employers and employees if they don’t support it. 

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Once this due diligence is completed, there is still one critical question to answer: the how. How do you take all of the requirements across the US and productize them? How do you  reduce the amount of information needed from employers and employees while still making accurate determinations across tax jurisdictions?And how do you create outputs to validate what you’ve built is compliant? It takes this and more to be compliant in each state.

And that’s just the beginning. Every tax is subject to change. Compliance teams must continuously monitor state legislation and government websites to learn of any changes, and be prepared for when they take effect. Not all tax agencies have websites, especially at the local level. A local jurisdiction in Kentucky, for example, publishes changes to their tax rates in the local newspaper. Other states announce changes in an employer portal that is not available to the general public. 

Staying ahead of state agency changes that impact how payroll platforms collect information, calculate taxes, and file returns helps in planning and allocating resources. A simple change to a tax limit or an agency’s filing requirements can mean weeks of work for engineering teams at payroll providers. And with each change, the cycle of questions starts again. Who does this change apply to? What is changing? Why is it changing? When does the change take effect? Where should the change be applied?

Whenever possible, payroll compliance teams want to identify trends in order to predict how states will react to changes made at the federal level. This allows payroll platforms to strategically reuse some of the work that has already been done and minimize the need to start from scratch. 

The risks of being a payroll provider

Being a payroll provider does not come without its risks. It’s extremely important for payroll providers to be compliant in all 50 states. The impact of one incorrect payroll can lead to cascading issues. In the example of Oregon’s PFML tax, let’s imagine that you didn’t realize that the tax goes into effect on January 1st of 2022. You never withheld the tax from your employees and you never reported wages to the tax agency. Now, an employee needs to use the benefits as part of the state’s paid family leave program. Because their wages were not reported to the state, the employee will not have access to those benefits. The employer will be fined penalties and interest for non-payment of taxes. And to make matters worse, the employer cannot go back and collect taxes from the employee because the state does not allow employers to recoup taxes from employees for a prior time period. 

Payroll is an extremely complicated space that impacts employers and employees in many ways. Getting it wrong isn’t an option. So, what can you do to ensure that the payroll product you build, use, or partner with is compliant? Here are your options:

1. Calculate it yourself and see if it matches your payroll provider's results (not recommended).
2. Hire an entire team of compliance experts and build a process from scratch (also, not recommended). 
3. Find a payroll partner that has their own team of compliance experts you can rely on, like Check.

To learn more about becoming a payroll provider in the US, download the full ebook.