Payroll Compliance Audit

Performs comprehensive payroll audits including worker classification, overtime, tax withholding accuracy, compliance checklists, and generates detailed repo...

Payroll Compliance Auditor

Run a full payroll audit in under 10 minutes. Catches the errors that cost companies $845 per violation.

What It Does

• Classifies workers (W-2 vs 1099) using the IRS 20-factor test
• Audits overtime calculations against FLSA rules
• Checks tax withholding accuracy (federal, state, local)
• Flags misclassification risk with dollar-amount exposure estimates
• Generates quarterly compliance checklists
• Produces audit-ready reports for DOL or state agency reviews

How to Use

Tell your agent:

Full payroll audit: "Run a payroll compliance audit for [company]. We have [X] employees across [states]. Pay frequency is [weekly/biweekly/monthly]."

Worker classification check: "Check if these roles should be W-2 or 1099: [list roles with descriptions]."

Overtime audit: "Audit overtime compliance. Our employees work [schedule]. We're in [state]. Current OT policy: [describe]."

Tax withholding review: "Review tax withholding setup for employees in [states]. We use [payroll provider]."

Audit Framework

1. Worker Classification (IRS 20-Factor Test)

Score each worker across three categories:

• Behavioral Control (6 factors): Instructions, training, integration, personal services, hiring assistants, work hours
• Financial Control (5 factors): Business expenses, investment, profit/loss opportunity, market availability, method of payment
• Relationship Type (4 factors): Written contracts, benefits, permanency, key services

Risk levels:

• 0-4 factors toward employee → Low risk (likely contractor)
• 5-9 factors → Medium risk (review needed)
• 10+ factors → High risk (likely misclassified)

Penalty exposure per misclassified worker:

• Back employment taxes: 15.3% of wages
• FLSA overtime liability: up to 3 years back pay
• Benefits liability: retirement, health, PTO
• IRS penalties: $50-$260 per W-2 failure
• State penalties vary: $5K-$25K per violation (CA, NY, MA highest)

2. Overtime Compliance (FLSA + State)

Check against federal AND state rules (state wins when more generous):

Rule	Federal (FLSA)	California	New York	Washington
OT threshold	40 hrs/week	8 hrs/day OR 40/week	40 hrs/week	40 hrs/week
OT rate	1.5x	1.5x (2x after 12 hrs/day)	1.5x	1.5x
Salary exemption	$58,656/yr (2026)	$66,560/yr	$62,400/yr (NYC)	$67,724.80/yr
7th day rule	None	1.5x first 8 hrs, 2x after	None	None

Common violations:

• Averaging hours across two weeks (illegal under FLSA)
• Not paying OT on bonuses/commissions
• Misclassifying non-exempt as exempt
• Rounding errors exceeding 7-minute threshold
• Auto-deducting meal breaks not actually taken

3. Tax Withholding Accuracy

Verify against current tables:

Federal:

• 2026 FICA: 6.2% SS (wage base $174,900) + 1.45% Medicare
• Additional Medicare: 0.9% above $200K single / $250K married
• FUTA: 6.0% first $7,000 (5.4% credit = 0.6% effective)

State cross-checks:

• SUI rates (experience-rated — verify annual notice)
• SDI/PFL (CA, NJ, NY, WA, MA, CT, OR, CO, MD)
• Local taxes (NYC, Philadelphia, San Francisco, etc.)
• Reciprocity agreements (employees in different state than work)

4. Quarterly Compliance Checklist

Monthly:

• Reconcile payroll register to GL
• Verify new hire reporting (within 20 days)
• Check garnishment calculations
• Review PTO accrual accuracy

Quarterly:

• File Form 941 (federal) by last day of following month
• File state unemployment reports
• Reconcile YTD withholdings to pay stubs
• Review contractor payments approaching $600 threshold
• Audit benefit deductions against enrollment

Annual:

• W-2 distribution by January 31
• 1099-NEC filing by January 31
• ACA reporting (1095-C) by March 2
• Update salary exemption thresholds
• Review state minimum wage changes
• Workers' comp audit preparation

5. Audit Report Format

PAYROLL COMPLIANCE AUDIT REPORT
Company: [Name]
Period: [Q1/Q2/Q3/Q4 YYYY]
Employees: [Count]
States: [List]
Audit Date: [Date]

EXECUTIVE SUMMARY
Overall Risk Score: [Low/Medium/High/Critical]
Issues Found: [Count]
Estimated Exposure: $[Amount]

FINDINGS
[F-001] [Category] - [Severity]
Description: [What's wrong]
Exposure: $[Amount]
Remediation: [Fix]
Deadline: [Date]

RECOMMENDATIONS
1. [Priority action]
2. [Secondary action]
3. [Long-term improvement]

Cost of Getting It Wrong

Violation	Average Penalty
Misclassification (per worker)	$12,000-$25,000
FLSA overtime (per employee)	$1,000-$10,000 + back pay
Late W-2/1099 filing	$50-$580 per form
Failure to deposit taxes	2%-15% of deposit
Willful failure	$100K+ fine + criminal

The DOL recovered $274M in back wages in 2024. Average investigation finds $1,150 per employee owed.

Who This Is For

• HR teams without dedicated payroll compliance staff
• Growing companies expanding to new states
• Businesses using contractors heavily (tech, construction, healthcare)
• Anyone who just got a DOL audit letter

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Built by AfrexAI — AI context packs for business operations. Full compliance automation: $47 Professional Services Pack.

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