A payroll audit is a systematic review of payroll records, tax filings, and practices to verify compliance with tax laws and identify errors or fraud.
Why payroll audits matter for employers
Payroll audits can be initiated internally by the employer as a proactive compliance check, or externally by federal or state agencies. The IRS conducts employment tax audits to verify that payroll taxes are correctly calculated, withheld, deposited, and reported. State agencies audit for income tax withholding, unemployment insurance, and workers compensation premium accuracy.
Internal payroll audits should be conducted at least annually and cover: verification that all employees are correctly classified (exempt vs. non-exempt, employee vs. contractor), that tax withholding matches current W-4s, that benefit deductions match enrollment records, that garnishments are being processed correctly, that W-2s accurately reflect wages and benefits, and that deposit schedules and amounts match payroll records.
IRS employment tax audits typically begin with a letter requesting payroll records including Forms 941, W-2s, W-3, payroll registers, bank statements showing tax deposits, and employee classification documentation. The audit scope can expand to include FUTA, backup withholding, and fringe benefit taxation.
State workers compensation audits verify that the correct payroll amounts were reported for premium calculation purposes. Misclassifying employees as contractors or underreporting payroll leads to premium deficiencies and penalties.
Common payroll audit findings include unreported fringe benefits, incorrect overtime calculations, misclassified workers, payroll tax deposits not matching Form 941, and benefit deductions not matching W-2 reporting. Addressing these proactively in an internal audit is far less costly than resolving them in a government audit.
How BEG prepares clients for payroll audits
BEG Managed Payroll maintains audit-ready records, conducts periodic internal reviews, and supports clients through government payroll audits as part of fully managed payroll at $25-$45 per employee per month. Learn about BEG Managed Payroll.
Frequently asked questions
What records should employers keep for a payroll audit?
Employers should retain payroll registers, Forms 941 and 940, W-2s and W-3, bank statements showing tax deposits, employee W-4s, benefit enrollment records, time and attendance records, and worker classification documentation for at least four years.
How long does an IRS employment tax audit take?
Simple audits may be resolved in weeks. Complex audits involving worker classification or multiple tax years can take 12-24 months. Having organized records significantly reduces audit duration.
What triggers an IRS payroll audit?
Common triggers include inconsistencies between Form 941 deposits and reported wages, sharp changes in reported wages year-over-year, a high ratio of 1099 payments to W-2 wages, whistleblower complaints, and random selection.
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About the author
Anthony Moretti is VP of Sales at Business Executive Group, where he builds BEG's managed payroll and HR service verticals for employers across Dallas-Fort Worth and nationwide. He writes the BEG Payroll Glossary to give employers plain-English answers on payroll and compliance.
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