Running a business is complicated, especially when you have employees. As a business owner, conducting regular payroll audits is vital for compliance with federal and state laws and making sure your processes are working. Here’s a concise step-by-step guide to help:
Why a Payroll Audit?
Payroll audits verify the accuracy of your documentation, ensure compliance, and prevent legal issues. It’s an intentional look into your system to identify and correct errors, enhance the organization of your records, and pay attention to potential opportunities for improvement. This helps build and maintain a strong foundation for your business. There are several steps taking place during this process.
A successful audit begins with the audit team. This team must be knowledgeable in the payroll process to ensure a comprehensive and unbiased assessment of your payroll processes. This includes external HR and accounting experts who are familiar with this process, as well as the payroll and tax laws, to provide insight as information is gathered. The team will have a list to ensure they cover all areas. These areas include documentation, employee information, payroll calculations, wage and hour compliance, tax withholdings, benefits and deductions, internal controls, and document and correct. A detailed explanation of each is listed below.
1. Documentation
What do you need for the audit? Your internal team should gather and organize all payroll records, timesheets, tax forms, and internal policies for the audit professionals. This simplifies the audit process and facilitates thorough reviews. You should have an internal team member on hand to gather additional documents when needed and ensure all checks and balances are followed while handling these confidential documents.
2. Employee Information
Employee rosters should be examined to verify the accuracy of the company’s employee details and tax withholdings. The team verifies if the employees listed on the roster are active, terminated, on a leave of absence, or furloughed. This helps maintain accurate financial reporting, preventing potential tax-related problems. All employees should be correctly classified.
Although independent contractors aren’t “technically” employees, they are a part of your team and should be included in your audit. They should be correctly classified to make sure you aren’t making any compliance mistakes.
3. Payroll Calculations
Double-check the accuracy of regular and overtime pay, all deductions, and bonuses to make sure employees are paid. This includes any tips, vacation pay, and any time differentials. You must also consider any signing bonuses, back pay, any previous corrections, and possible relocation pay.
These are areas that are often overlooked or have issues. Everything should be labeled correctly: sick time, holiday pay, bereavement, jury duty, etc. This helps in correctly tracking accruals. Your payroll records should match the general ledger and bank accounts. Here are a few things to consider:
- Are all pay periods correct?
- Do those pay periods match the lookback period?
- Have all employees been paid on time and at the right rate, including any bonuses?
- If their pay rate changed, was it done on the correct effective date?
- Do you have any employees that have been found to be misclassified?
- Are there any garnishments that must be addressed?
- Are there any Health Savings Accounts or similar accounts that need deductions?
4. Wage and Hour Compliance
Confirm employee classification, overtime pay, and alignment with the current minimum wage standards for your state. Complying with payroll rules is important, especially if you have employees working in multiple states.
5. Tax Withholdings
Review your payroll tax calculations and reporting to make sure you’re withholding the correct amount for your employees. Income taxes may differ if you have people working in different states or if they used to work in the office and now work from home. Check to make sure the federal, Medicare, and Social Security taxes were correctly withheld. Other areas to pay attention to include:
- Federal and state unemployment taxes
- Employee W-4s
- State and local taxes based on employee location
- Does the tax information match the 940 and 941 forms?
6. Benefits and Deductions
Benefits are good incentives for employees but must be carefully monitored to avoid discrepancies. Check to safeguard all contributions to retirement plans, insurance, and other deductions.
7. Internal Controls
Evaluate payroll procedures for efficiency and accuracy, identifying areas for improvement to reduce the risk of errors. You may find that you need to correct some areas of the process. This is a good time to determine if your time clock system is working and meeting your needs, whether accruals are being done correctly if managers need to start reviewing timecards, and who’s handling payroll.
You may have to add additional layers to your current payroll process to avoid making mistakes or errors. Automation is a good way to circumvent some of these issues while having a solid system for tracking. Employees should be confident they are receiving accurate data on their pay records. Make sure they are receiving a pay stub that includes the hours worked, their deductions, and overtime pay.
8. Document and Correct
Keep detailed records and immediately address any discrepancies or issues. A healthy management process for your payroll is key to remaining compliant and accountable. There should be a timeframe for your payroll audit to take place, and an audit schedule should be in place for periodic checks.
The team will report any findings in a payroll audit report to the management team. This should include the head of HR and the head of Finance. This provides a basis for where to start correcting errors if needed.
By following this guide, you’ll maintain compliance, protect your business, and create a fair work environment for your employees. Remember to consult with experts for industry-specific advice and tailor the audit process to your business needs.
