FAQs About Payroll Audits
Payroll Audits FAQs
Payroll audits help employers identify errors, compliance risks, and process weaknesses before they become costly problems. A thorough payroll audit can examine employee records, wages, overtime, payroll taxes, deductions, garnishments, worker classifications, payroll reports, and state requirements.
The Payroll Audits FAQs from Payroll Training Center provide answers to common questions about conducting payroll audits, preparing for an audit, reviewing payroll records, reconciling payroll taxes, identifying errors, and improving payroll processes.
These FAQs are designed for payroll professionals, HR professionals, accountants, bookkeepers, controllers, business owners, and anyone responsible for payroll compliance.
Important: Payroll requirements vary by federal, state, and local jurisdiction and can change over time. This page provides general educational information and should not be considered legal, tax, accounting, or employment advice.
General Payroll Audit FAQs
Most employers first think about payroll audits only when they receive notice of one from the government. The better position is to run your own first, as internal self-audits can find the same things an examiner would — and without the fines, penalties, and aggravation.
What is a payroll audit?
A payroll audit is a systematic review of payroll records, calculations, processes, and related documentation to determine whether employees have been paid correctly and payroll requirements have been properly followed.
A payroll audit can examine:
- Employee information
- Pay rates
- Hours worked
- Overtime
- Bonuses
- Commissions
- Deductions
- Payroll taxes
- Garnishments
- Employee classifications
- Payroll reports
- State and local requirements
- Payroll accounting records
Why are payroll audits important?
Payroll audits can help employers identify:
- Overpayments
- Underpayments
- Payroll tax errors
- Incorrect deductions
- Incorrect employee classifications
- Missing documentation
- Reporting errors
- Duplicate payments
- Incorrect overtime calculations
- State payroll compliance issues
Regular audits can also improve payroll processes and internal controls.
How often should a payroll audit be performed?
There is no single schedule that applies to every organization. Employers may conduct payroll audits annually, quarterly, periodically throughout the year, or when a specific risk or business change occurs. Organizations with large workforces, multiple locations, or complex payroll structures may benefit from more frequent reviews.
Who should conduct a payroll audit?
Payroll audits may be conducted by:
- Payroll managers
- Payroll specialists
- HR professionals
- Accountants
- Internal auditors
- Controllers
- Compliance professionals
- External auditors
- Third-party payroll consultants
The appropriate person depends on the organization's size, complexity, and internal control structure.
Payroll Audit Preparation FAQs
How should an employer prepare for a payroll audit?
A payroll audit can begin by gathering:
- Payroll registers
- Employee records
- Time records
- Pay rates
- Tax filings
- Tax deposit records
- Payroll reports
- Deduction authorizations
- Garnishment orders
- Benefits records
- Worker classification documentation
- Payroll policies
- General ledger records
What should be reviewed before starting an audit?
Before reviewing individual transactions, auditors should understand the organization's:
- Payroll system
- Pay frequency
- Employee population
- Work locations
- Pay practices
- Payroll providers
- Tax jurisdictions
- Deduction policies
- Overtime policies
- Payroll approval procedures
Should payroll create a payroll audit checklist?
Yes. A standardized checklist can help ensure that important areas are reviewed consistently.
What employee information should be reviewed?
A payroll audit can review:
- Legal name
- Address
- Social Security number or other required identification information
- Employee status
- Hire date
- Termination date
- Pay rate
- Pay frequency
- Work location
- Tax withholding information
- Direct deposit information
- Benefit deductions
What payroll calculations should be reviewed?
Depending on the employee and payroll system, an audit can review:
- Regular wages
- Overtime
- Double time
- Bonuses
- Commissions
- Shift differentials
- Paid leave
- Holiday pay
- Retroactive pay
- Deductions
- Taxes
- Net pay
What kinds of payroll audits are there?
Four common types include an internal self-audit, an IRS employment tax examination, a Department of Labor wage and hour investigation, and state audits for unemployment insurance, withholding, or workers' compensation premiums.
These audits can focus on different areas, so preparing for one type of audit does not necessarily prepare an employer for another. Workers' compensation premium audits are among the most routine payroll-related audits and are frequently mishandled.
What triggers a payroll audit?
Common triggers include an employee complaint, a worker filing for unemployment after being treated as a contractor, mismatches between quarterly Form 941 filings and annual W-2 totals, large or unusual changes in reported wages, industry-targeted enforcement initiatives, information sharing between agencies, and random selection.
A single unemployment claim from a purported contractor can be one route into a broader worker-classification audit.
What does an internal payroll self-audit cover?
At minimum, an internal payroll self-audit should consider worker classification for both contractor status and exempt status; time records against paid hours for nonexempt employees; overtime calculations, including whether bonuses were included in the regular rate when required; taxability of fringe benefits and reimbursements; garnishment calculations and remittances; deposit timeliness; reconciliation of Forms 941 to W-2s and the general ledger; state registrations for every state where employees work; and access controls over the payroll system.
How often should an employer self-audit?
An abbreviated review can be performed quarterly as part of payroll reconciliation, with a full review annually before year-end so corrections can be addressed in the appropriate tax year. Additional reviews should follow any material change, such as a new state, acquisition, payroll system conversion, or change in payroll provider. System conversions in particular can create configuration errors that may not be immediately apparent.
What payroll deductions should be audited?
Depending on the employer, deductions can include:
- Health insurance
- Retirement contributions
- Flexible spending accounts
- Garnishments
- Child support
- Union dues
- Voluntary deductions
- Wage advances
- Benefit deductions
What should payroll verify for deductions?
An audit can verify:
- Employee authorization
- Correct deduction amount
- Effective date
- Termination date
- Applicable legal limits
- Proper remittance
- Correct payroll system setup
What findings come up most often?
Common findings include fringe benefits treated as nontaxable when they are taxable, particularly gift cards, awards, and personal use of a company vehicle; regular rates calculated without including required nondiscretionary bonuses; salaried employees who fail applicable duties tests; contractors who fail the applicable classification test; unregistered states; garnishments calculated incorrectly; and unreconciled differences between Forms 941 and W-2s.
What happens during an IRS employment tax examination?
An information document request generally specifies the periods and records requested. The examiner may review returns, deposits, payroll registers, contractor payments, and fringe benefit treatment. Interviews may follow, and the examination may conclude with proposed adjustments that the employer can generally agree to or contest through applicable procedures. Worker classification and fringe benefit taxability are recurring areas of examination.
What happens in a DOL wage and hour investigation?
The investigator may review payroll and time records, interview employees privately, and calculate back wages for violations that are identified. Investigations can expand beyond the employee who made the complaint to similarly situated employees and prior periods. Findings may include back wages and, where applicable, liquidated damages. Willful violations may also involve a longer lookback period.
What is a workers' compensation premium audit?
A workers' compensation premium audit is generally an annual reconciliation by the insurer of actual payroll and employee classifications against the estimates used to establish the policy premium. Misclassified employees, incorrect class codes, underreported payroll, and uninsured subcontractors can affect the final premium calculation. Maintaining certificates of insurance for applicable subcontractors can be an important internal control.
How should an employer respond to an audit notice?
Employers should confirm the scope and periods covered by the audit, designate one point of contact so the agency receives consistent information, assemble the requested records, and review the records internally before producing them. Employers should also consider obtaining professional advice when worker classification, potential willfulness, significant wage claims, or other complex compliance issues are involved.
Can an employer correct problems voluntarily before an audit?
Often, and early correction can help limit the consequences of payroll errors. Depending on the issue, correction methods may include amended returns, applicable IRS voluntary classification programs, and back-wage payments for wage and hour errors. Eligibility for certain correction or settlement programs may depend on whether an audit or investigation has already begun. Employers should evaluate known problems promptly and determine which correction procedures may be available.
