Payroll record keeping requirements are a headache. But they are also 100% an absolute necessity. Try applying for a loan without a good payroll record-keeping system. Or filing your taxes. You need to have a good system in place.
Poor record-keeping has been the case of many lawsuits and fines. You need to keep records, not just in case of an event or a lawsuit, however. It is a legal mandate that you keep appropriate payroll records, for a variety of different reasons.
As a rule of thumb, all documents need to be kept for 3 years, but there are some instances where you need to keep them for longer or shorter periods.
Table of Contents
- What are the Major Record-Keeping Requirements?
- Who Enforces the Major Record-Keeping Requirements?
- Complying With Payroll Record-Keeping – Step by Step
- What are the Major Employee Forms to Keep?
- Employee Forms: Length of Record Retention (General)
- Employee Forms: Length of Record Retention (Agency/Law Specific)
- IRS Penalty Table For Late Submission
- State-Specific Laws For Employee Records
- Intricacies of Paper and Digital Storage
- Correct Disposal of Employee Records
- How Do I Record Freelancers and Contractors?
- What About Zero Hours/On-Call Workers?
- Main Points to Consider
- The Best Way to Handle All Payroll Record-Keeping Requirements
- The Bottom Line
What are the Major Record-Keeping Requirements?
The major record-keeping requirements are set out by the FLSA. Note that there are no specific documents you need to keep. But you need to store documents that display the following:
- Employee’s full name and social security number
- Address, including zip code
- Birthdate, if younger than 19
- Sex and occupation
- Time and day of the week when the employee’s work-week begins. Hours worked each day and total hours worked each workweek
- The basis on which employee’s wages are paid
- Regular hourly pay rate
- Total daily or weekly straight-time earnings
- Total overtime earnings for the workweek
- All additions to or deductions from the employee’s wages
- Total wages paid each pay period
- Date of payment and the pay period covered by the payment
All this should be recorded automatically with high-quality payroll/onboarding software. The employee can fill in their details and work will be paid automatically based on a scheduling software which tracks time worked.
Payroll records are to be kept for at least 3 years according to the Department of Labor. The records on which wages were based(timecards, wage rate tables, work, and time schedules, etc) may only be kept for 2 years. Tax documents like the W2 and the W4 should be kept for a minimum of 4 years, according to IRS guidelines.
Who Enforces the Major Record-Keeping Requirements?
There are both Federal and state recordkeeping requirements to be tended to. However, there are also industry-specific guidelines. Certain industries, such as underwriting and insurance, might have more extensive record-keeping requirements. In the old days, insurance companies would lease out warehouses to store (physical) client records, at an enormous cost. Thankfully, we have come a long way in the past decade. The major record keeping requirements include:
- The Fair Labor Standards Act (‘FLSA’) – This is the primary piece of legislation governing record-keeping and many other aspects of employment law. The FLSA stipulates the minimum wage that workers are to be paid, what information needs to be kept with regard to employees, overtime, and guidelines on youth labor
- The Department of Labor (‘DOL’) – While the FLSA is a piece of legislation, it is the DOL and the IRS that are the Federal agencies responsible for the enforcement of this legislation (though mainly the DOL). This is a huge agency with many functions, namely ensuring compliance with employment law and fair treatment of workers.
- The Internal Revenue Service (‘IRS’) – The IRS is responsible for taxation and the issuance of work-related documents. Most notably, it is the IRS that will give you forms W2, 940, and W4 (more on these later)
- Equal Employment Opportunity Commission (‘EEOC’) – This Federal department is mainly concerned with workplace discrimination but is also involved in some areas of employee recordkeeping
The main governing authority over record-keeping is the DOL, which implements the FLSA. The IRS is concerned with taxes and the EEOC with discrimination. However, the EEOC can stipulate individual record-keeping requirements for areas within their jurisdiction. Also, states and industries can also have their own unique requirements, which can make it a little tricky. For instance, the EEOC has the authority to:
“impose recordkeeping requirements upon individual employers or groups of employers.”
The bottom line is that you will have to do your own research and find out the relevant laws to your current situation. With that said, let’s take a look at a step-by-step process to comply with payroll.
Complying With Payroll Record-Keeping – Step by Step
For business owners eager to comply with the essential record-keeping requirements, there are a number of steps to take. The good news is that, despite the complexity, payroll record-keeping is easy and streamlined once you have put in the initial work. It just takes a while to get familiar with all of the bureaucratic rules that are problematic, but necessary.
#1 – Read
The first step is to read up on all relevant literature of what needs to be kept, for how long, and what needs to be submitted to the IRS at the end of each tax year. Get familiar with the legislation (FLSA) and the enforcement agencies (IRS and DOL). Next, it’s time to read up on state laws governing your industry. This will give you an idea about what form needs to be kept.
#2 – Get Familiar With Forms
After you have become familiar with the agencies and the law, you want to become familiar with the basic tax and record-keeping documents (the two being very much intertwined). The 5 most basic (and important) documents you need to know about include:
- I9 – Also known as the Employment Eligibility Status form, overseen by the Department of Homeland Security. All business owners must have this, which indicates the legal/immigration status of each employee.
- W4 – This IRS form is completed by the employee and sent to the employer. It tells the employer how much to withhold in taxes.
- W2 – This IRS form is filled out by an employer for each and every employee. It is also known as the ‘Wage and Tax Statement’.
- Form 1040 – This IRS form is associated with the tax return for every US individual taxpayer. It is one of the most common and is often accompanied by a Schedule 1, Schedule 2, or Schedule 3.
#3 – Make a List
This might seem a little archaic. But it can really help to make a list or spreadsheet of all the documents that you need to submit/retain for each employee, and for you as a business owner. Even if this step can be termed redundant (there is software available that automatically produces payroll records), it is useful to learn more about the payment and tax ecosystem. As a business owner, you need to understand forms, taxes, and governing authorities. This will eventually help you to fill them out faster and to investigate how best to legally reduce taxes, by being familiar with what is typically required.
#4 – Streamline Employee Onboarding
When employees are first onboarded, they should have to fill out an I9 and W4 as part of the process. They will make it easier for employers to have this information at hand. The onboarding process should be tied into payroll and time tracking systems so that everything is integrated. The more smoothly all of your business systems are interconnected, the easier it will be to retrieve data and spot errors.
#5 – Enhanced Payroll Processing
All payroll, timekeeping, and bookkeeping should be automated. What this means is that pay stubs and other records should be automatically generated with each payment, and all of these records will have the requisite totals, time stamps, dates, overtime, bonuses, and practically all other information.
Just make sure that each category is clearly labeled. Sick leave is sick leave. Overtime is overtime. Bonuses are bonuses. Holiday pay is holiday pay. Do not just manually enter a figure to pay employees to get the job over with. This will have negative tax and recordkeeping implications. It’s not just if you fail to keep records that you could get a fine. It’s if you fail to keep accurate records, which amounts to basically the same thing from a legal perspective.
#6 – Review
Depending on the size and nature of your business, you may want to investigate HR functionality or an HR team that can go over the documents for each and every employee to ensure that all the documents are there. Again, try to get as much information as you can, as early as you can, from the employee. After this, most of the reports and storage should be automated via software. If in doubt, keep as much as you can, as long as you can. The price of storage has gone way down, and word/pdf documents have a tiny file size, made even small with file compression.
What are the Major Employee Forms to Keep?
The forms to keep are not so important as the data. The legislation stipulates that you need to document the information, and is not all that concerned with how. You need to demonstrate source documents for payment such as work schedules, time cards, piecework tickets, wage rate tables, and records concerning wage deductions or additions, along with records used by the employer to determine costs associated with additions or deductions.
Whatever system you use to track this is fine, so long as everything is in order. With that said, the major employee forms you will be keeping, as per the IRS guidelines, will include:
- Your employer identification number
- Amounts and dates of all wage, annuity, and pension payments
- Amounts of tips reported
- The fair market value of in-kind wages paid
- Names, addresses, social security numbers, and occupations of employees and recipients
- Any employee copies of Form W-2 that were returned to you as undeliverable
- Dates of employment
- Periods for which employees and recipients were paid while absent due to sickness or injury and the amount and weekly rate of payments you or third-party payers made to them
- Copies of employees’ and recipients’ income tax withholding certificates (Forms W-4, W-4P, W-4S, and W-4V)
- Dates and amounts of tax deposits you made
- Copies of returns filed
- Records of allocated tips
- Records of fringe benefits provided, including substantiation
You will also want to retain the employee’s I9 form for at least 2 years. You might notice a spillover in terms of tax forms and payroll forms, and this is normal. Payroll is intimately connected with taxes, and they are, in many ways, inseparable. This is why the IRS is also involved in issuing payroll guidelines.
However, keep in mind that these forms are the record-keeping requirements that are only relevant to payroll. There are different requirements depending, first on the state, then on the industry, then on the area (hiring records, personnel records, medical records, demographic records, etc) within a given business!
Employee Forms: Length of Record Retention (General)
There following is a table outline the minimum time you need to hold on to payroll documents. Anything related to the payroll is subject to the guidelines set out by the DOL and IRS in accordance with the FLSA act. However, there are extra rules for benefits and employment disputes which are in a class of their own.
Basically, you need to keep termination documents or 7 years, medical benefits and retirement income details for 6 years, tax forms and paystubs for 4 years, hiring forms, timecards, and I9s for 3 years, and other information (hiring information, paygrade info, merit increases) for 2 years.
|Types of Payroll Records||2 Years||3 Years||More than 3 Years|
|Merit Increases and Pay Grade||✔|
|FMLA Leave Details||✔|
|Tax Documents Like W-4s||4 Years|
|Retirement Income and 401(k) Plan Details||6 Years|
|Any Documents Relating to a Payment or Employment Dispute||4 Years|
|Termination Documents||7 Years|
Employee Forms: Length of Record Retention (Agency/Law Specific)
Knowing how long to keep records can be a little confusing, not only because there are so many different types of documents. But also because different agencies and laws provide information that can only be described as contradictory.
Remember that a payroll record includes, Employer identification number (EIN), Employer tax forms (reports) and payment (deposit) receipts, IRS notifications regarding payroll taxes, including the employer’s remittance frequency status, amounts of tips reported for businesses with tipped employees, amounts and dates of all taxable wage, annuity, and pension payments, bonuses and commissions. It also includes employee information – addresses, social security numbers (SSNs), occupations, dates of employment, and tax documents (W-4s and W-2s).
The following table outlines the time you should keep payroll. It’s probably best to keep all documents for a minimum of 4 years, just to be safe.
|Governing Legislation/Body||Length of Record Retention|
|Fair Labor Standards Act (FLSA)||3 Years (2 For Supplementary Documentation)|
|Internal Revenue Services (IRS)||4 Years|
|Occupational Safety and Health Act (OSHA)||5 Years|
|Equal Employment Opportunity Commission (‘EEOC’)||3 Years|
|Family and Medical Leave Act (FMLA)||3 Years|
|Americans With Disabilities (ADA)||1 Year|
|Individual State Requirements||3 Years – 8 Years|
IRS Penalty Table For Late Submission
The following table represents the penalties you can expect to pay for late submission of payment forms including Forms 1098, 1099, W-2G, and W-2. There are two separate kinds you could be hit with – one for failing to submit to the IRS, the other for failing to submit to the worker/contractor. You will incur the IRS below penalties when you:
- Don’t file a correct information return by the due date and a reasonable cause is not shown
- File on paper when you were required to file electronically
- Don’t report a Taxpayer Identification Number (TIN)
- Report an incorrect TIN
- Don’t file paper forms that are machine-readable.
|Small Businesses with Receipts of $5 Million or Less|
|Time returns filed/furnished||Before 30 days late||31 days late until August 1||After August 1 (Or never)||Intentional Disregard|
|$50 per return or statement and
|$110 *per return or statement and
|$270* per return or statement and
|$550* per return or statement –
|$50 per return or statement and
|$100 per return or statement and
|$270* per return or statement and
|$540* per return or statement –
|$50 per return or statement and
|$100 per return or statement and
|$260* per return or statement and
|$530* per return or statement –
|$50 per return or statement and
|$100 per return or statement and
|$260* per return or statement and
|$530* per return or statement –
State-Specific Laws For Employee Records
States will often have specific requirements not mandated at the Federal level. For instance, the scope and length of record-keeping requirements may vary from the typical 3 years. Certain documents that are only required to be kept for 2 years at the FLSA level have to be kept for 3 years at the Federal level. This is why it is important to check up on state-specific recordkeeping laws and industry-specific recordkeeping laws.
While federal law does not require the employer to provide employees with pay stubs, many states do. This is an area that would be easy for a business owner to overlook, and the end result could be a hefty fine for non-compliance.
A prominent example is California, which tends to always have vastly different laws from those imposed at the Federal level. In California, employers must maintain accurate information for each employee in English in ink or another unalterable form. The information must be dated and kept on file for at least three years at the place of employment or a central location within the state. Employers must record additional information for California non-exempt employees, such as meal periods and split-shift intervals. When applicable, piece rates or an explanation of an incentive plan formula must be recorded and provided to California employees.
This is merely one example. The thing to remember is that your state could easily have different requirements for payroll record-keeping. While the FLSA does not require business owners to issue pay stubs, 26 states do. Issuing pay stubs is an easy way to keep track of the essential information.
Intricacies of Paper and Digital Storage
Storage of documents is simply not cheap, despite all of the innovations in hardware and software. Though the figures may vary, the average cost to store a TB of data is $3,400. This figure might seem like a lot, but it takes into account all the ancillary services. A typical IRS document might be only 50KB, meaning you could store 400 documents for every GB of data, and a whopping 40,000 forms in a TB of data.
But when you couple this with files that have images and the storage of videos, that TB of data gets eaten up very quickly. You need to generate files all the time, with every year and every new hire. Data needs to be backed up, reviewed, software needs to be updated, and privacy features need to be enhanced.
For a small business owner, the cost can be relatively inexpensive provided some safeguards are put in place with a high-level software system. Store only the essential forms and compressing them will enable you to keep in line with the law and payroll recordkeeping requirements easily, at a low cost.
Physical storage is far more expensive, where you will often be charged by the box. If you store documents in a physical office, you need to invest in a filing cabinet (around $350 on average) and it will still cost you ink and paper. A box of paper costs $17.50 on average and you can fit around 8 boxes of paper. In other words, physical storage is really inefficient when all the costs are added up. Only store physical files when absolutely necessary, and use cloud-based solutions in the meantime.
Correct Disposal of Employee Records
If you fail to correctly dispose of employee payroll records properly, then you could easily be the victim of a fine. In 2012, the Federal Trade Commission (‘FTC’) alleged that PLS Financial Services Inc and The Payday Loan Store of Illinois Inc failed to correctly dispose of employee records.
The result was a $101,500 settlement out of court. The documents, containing personally identifying information (medical records, social security numbers, financial records, background checks), were thrown in a dumpster.
The good news is that the means you use to dispose of the information are flexible. Businesses can take into account how sensitive the information is in order to determine how to dispose of it. The FTC does, however, recommend the following:
- Destroying or erasing electronic files so that consumer information cannot be read or be reconstructed
- Shredding, burning, or otherwise destroying paper documents so that consumer information cannot be read or reconstructed
- Hiring a certified contractor specialized in document destruction after performing due diligence of the company’s operations and security policies
The best thing to do is to go as far as possible in eradicating the document so that nobody can read or access it. The fact that the FTC referred to the practice of reconstruction is ominous, given that hackers could potentially take the time to reconstruct files from a compromised network with erased files. A third-party can be hired to remove these documents, though this could be cost-prohibitive.
How Do I Record Freelancers and Contractors?
It is a lot easier to keep records for freelancers and contractors. Instead of the form W2 that you will give to each of your employees, you will give them a form 1099 MISC. And you only have to do this when the contractors/freelancer has been paid more than $600. Due to the fact that you don’t withhold or pay any payroll taxes with respect to these workers, payroll recordkeeping tends to be a lot more streamlined with freelancers and contractors.
Form 1099 is required to be sent to the contractor/freelancer and postmarked by Jan 31st of each year. It is a summary of the total income paid to that contractor in the year previous to that January. The payer must send to the IRS by the end of February a summary of all the 1099 forms they sent out. The IRS may double-check this against the income reported by the contractor/freelancer.
However, there is a level of uncertainty here. You need to make sure that the workers are independent contractors and not employees. The IRS has a 20-factor test to determine the difference. If they satisfy more than 10 factors, then they are workers and not independent contractors. To make matters a little more complex, the FLSA has its own tests and criteria for determining the difference.
The IRS frowns on the extensive use of independent contractors because it is more difficult to enforce the payment of payroll taxes. For instance, a business owner with 500 employees is easier to keep in line than 500 independent contractors. Still, working with independent contractors means you avoid recordkeeping in relation to:
- The Federal Insurance Contribution Act (FICA)
- The Federal Unemployment Tax Act (FUTA)
- The Consolidated Omnibus Budget Reconciliation Act (COBRA)
- Workers’ Compensation Insurance
- Retirement and Benefit Plans
- Paystubs, timecards, hiring documents, handbooks, and other payroll-related documents.
Independent contractors and freelancers are self-employed in the eyes of the IRS. As such, they are responsible for maintaining their own recordkeeping requirements. Using freelancers and contractors is a great way to reduce costs and recordkeeping requirements, but you need to ensure you are not using them as you would a regular employee.
What About Zero Hours/On-Call Workers?
In comparison to freelancers/independent contractors, on-call workers are a different story. An on-call worker is an employee, for all intents and purposes (on-call workers are referred to as zero-hour workers in the UK). This means all of the standard forms and documentation need to be maintained. On-call workers are employees.
In fact, recordkeeping and payroll are more complex in terms of on-call workers, and the legal landscape is more dubious. There is a lot of legal uncertainty surrounding on-all workers because when workers are on-call, they are not technically at work. When workers are on-call and have to work, then the wage is often more than the standard wage, or else they get paid a reduced wage for on-call workers who are hanging around near a computer.
But as far as recordkeeping is concerned, on-call workers have the exact same requirements in comparison to regular workers. The only real benefit would be fewer hours worked overall.
Main Points to Consider
The main points to keep in mind with regard to payroll recordkeeping are:
- Different Regulatory Agencies -There are various authorities that govern payroll requirements. The IRS states that all payroll records should be kept for 4 years, while the FLSA stipulates 3 years for most documents, and 2 for the rest. The SBA recommends keeping records for 6 years, certain industries have agencies advising 7 years, and the state may have specific laws for payroll records
- Independent Contractors – While it might be tempting to use a lot of independent contractors as employees, the risk is quite severe. Do not use terms like salary or wages in terms of compensation, or the IRS will tend to view such workers are employees. The more control you exert over independent contractors, the more you will be seen as their employer. If this happens, you will have a terrible amount of record-keeping requirements to take care of
- Efficiency and Organization – You need to have an efficient storage mechanism in place to cater to all of the various files that need to be kept. The files need to be easily retrieved. But you also need to ensure that the files themselves are correctly filled out and submitted on time. You will get fined for filing late or for incorrectly files forms
- Keep Forms For The Long-Term – Clearly, there is a lot of ambiguity in terms of how long to keep each record. It’s probably a better idea to keep all manner of files for a uniform period of 6 years or so. This will keep you covered and while it might cost a little more, the increased cost is worth the risk, especially if you have an efficient (and secure) cloud-based storage mechanism
The Best Way to Handle All Payroll Record-Keeping Requirements
The most obvious and straightforward mechanism to handle all payroll record-keeping requirements is through a software system that does it all automatically. To put it in simple terms, the problem with payroll record-keeping is that there are so many regulatory agencies with different requirements. There are many forms and different classes of workers.
The beauty of payroll software is that all of these peculiarities are in-built. The software is automatically updated when the laws change, as they often do. The payroll software can also take into account your state of operation and will help with employee onboarding. While many of them have different functions, most payroll providers can help with payroll recordkeeping.
HR software is also an option to take care of more than just direct payment records, with employee document repositories that may extend to all aspects of employment.
Payroll record-keeping is a pain. At least at first. When you become more familiar with it, then it becomes second nature. The forms can be automatically generated and stored on the same platform. You get reminders before submission deadlines.
The bottom line is that if you are organized with payroll record-keeping, then you won’t have a problem. And if you aren’t organized, then you will have a major problem. Get on top of it sooner, rather than later, and the regulatory authorities will have no reason to be in touch.
What Are Payroll Records?
Payroll records are the documents you keep to track and inform everything regarding an employee’s paycheck. They cover hours worked, wages, taxes, benefits, and any other financial or important information related to paying an employee. Payroll records can be physical, digital, or a combination of the two.
Why Should I Keep Payroll Records?
There are a million reasons you need to keep payroll records. The most obvious is that there are many, many, many authorities that will crack down on you and impose fines if you fail to file and store records, intentionally or not. These agencies include the IRS, the DOL, the EEOC, and the DHS, could easily pay you a visit. There are other practical reasons to keep payroll records. They can come in useful in the event of litigation (the onus often being on the employer to prove hours worked). They can also help your business to be more streamlined and organized. It will give you more financial control and you will be very thankful that you kept such good records if you decide to sell your business.
What Are the Most Relevant Payroll Records to Keep?
The most common payroll records, for the purposes of legislation and reporting, are the W2, W4, Form 941, and Form 940. The W2 is completed by the employer at the end of the year, reporting key information about the employees. The W4 is handed to the employee at the start of the employment, and the employee has to fill this out. Form 941 is related to an employer’s quarterly tax, and Form 940 relates to the employers’ annual tax. As well as this, you need to keep a record of paystubs, new hire reports, and wage detail reports. Tax returns should be kept longer than wage reports, and are the domain of the IRS.
How Long Do I Have to Keep Employee Forms?
It depends on what kind of form you are talking about. There are different requirements for hiring records, medical records, payroll records, benefit plan records, etc. Generally, you will have to keep payroll forms on file for 3 years. Other employee forms may need to be kept up to 6 years. This will depend on the legislation and the area – benefit forms, medical forms, litigation forms, immigration forms, hiring forms, marketing forms, etc. Each area has specific guiding departments and legislation.
How Much Does Record Maintenance Cost?
Record maintenance is something of a buzzword. You are not actually paying for the storage of the form itself – storage is cheap for word/pdf files. But record storage comes with other capabilities such as document signing and document creation, often integrated as part of a wider HR software. It is rare to pay just for record storage, as this is quite a basic feature, that you can do yourself with a secure server and a desktop file system. But, as always, you will pay for ease and convenience. Storing 1 TB of data costs around $3,000 annually.
What Kind of Software System Tends to Record Payroll?
Practically all of the payroll software will also double in the sense of recording vital documents. The documents can be generated and stored on the same system. The payroll software will also typically provide onboarding functionality and be linked with an accounting software platform. Sometimes, the payroll software will double as an accountancy platform. You could also use a typical document storage software like Zoho Docs.
Should I Outsource My Record-Keeping Requirements?
Generally, it is not the best idea to outsource your recordkeeping requirements. Recordkeeping is integral to your business model. It is intimately tied to accounting, tax, payroll, and employment. That is a lot of sensitive data to give to a third-party. What you can most certainly do is get software that automatically creates and stores sensitive data. The most relevant would be payroll software such as Patriot software or OnPay. The employees can be automatically issued W2s and will self-onboard. You will be reminded of tax deadlines and all files can be stored within the database platform. Recordkeeping should be automatically tied in with timekeeping and payroll. It streamlines everything for you, without the risk of a third-party.
What Are the Penalties for Failure to Comply With Employee Record-Keeping?
The penalties that can be imposed for failure to keep, maintain, and dispose of employee records can be quite steep. There is a 100% penalty for willfully withholding taxes such as FICA. This means you will be on the hook for the entire amount withheld. If you did it unwillingly (such as wrongfully classifying a worker as an independent contractor) you will be responsible for a lesser percentage. If you fail to file a W2 on time, there is a $50 penalty for each form, to a maximum of $187,500 for small businesses. The penalties increase the longer you fail to submit the forms. Failure to dispose of the information correctly is dealt with on a case-by-case basis.