Payroll Compliance Audit

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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