Bookkeeping – Payroll Compliance and Documentation (Lesson 33)
The key to success with payroll accounting is properly documenting all aspects of payroll thus complying with the various legal requirements. There are several authorities that govern payroll including:
- Internal Revenue Service
- Respective State Department of Revenue or Taxation
- State’s Department of Unemployment
- Social Security Administration
- Worker’s Compensation Insurance
But in reality, the most important authority is the employee. Good organization allows you to retrieve information easily and comply with the respective law and regulations.
This lesson explains the compliance requirements and proper documentation procedures. I’ll illustrate the best example of documentation that I’ve witnessed in my 20 plus years of accounting. Hopefully the reader will realize that compliance is not much more than a methodical process.
The dominant authority for compliance is the United States Congress, specifically Section 31 of Chapter 26 of the United States Code. The law promulgated by regulations as follows:
Section 31.3401(a)-1 and Section 31.3102-1(a)
Failure to collect both income and FICA (Social Security and Medicare) from the employee shifts the liability to the employer for these taxes.
Failure to pay taxes over to the Internal Revenue Service is a Section 7202 criminal offense and is punishable by up to five years in prison.
The government looks to owners first for payment and then for civil action against any responsible party in the enterprise’s administration. There is a remote possibility that the bookkeeper can be held financially liable. I encourage all bookkeepers to not sign any tax document, form or letter to the IRS. This is the job of the owner, not a bookkeeper.
Record keeping in general for payroll is governed by Section 31.6001-1 (Records in General). There are three requirements pertaining to the bookkeeper.
- Section 31.6001-1(a) Form of Records – must be accurate to the penny
- Section 31.6001-1(b) Copies – must maintain copies of all records including those submitted to the IRS
- Section 31.6001-1(e) Place and Period – must maintain documents in a convenient and safe spot; accessible by agents of the Internal Revenue Service for a least four (4) years after submitting the final W-3 for the respective calendar year.
In addition, each state uses similar language in regards to collection of income taxes and documenting compliance for state unemployment tax.
The final compliance authority is the insurance underwriter. Rarely are small businesses exempt from insurance payroll audits. The insurance auditors are not looking to see if taxes were paid. They are looking for the gross wage calculation for the different work codes. Lower risk codes such as office personnel pay lower premiums; but high risk workers such as roofers or electricians require significantly greater premiums. In their audits, they want to know gross wages paid and the employee’s function with the company.
To successfully pass all the above tests a bookkeeper must have a solid documentation process and system.
I encourage bookkeepers and accountants to organize information in both a paper and electronic format. To prepare, follow these instructions:
Paper Filing System
You will need the following supplies:
- A single file cabinet drawer for 15 or less employees for a calendar year
- Two drawers for up to 50 employees for a calendar year
- File folder holders and folders
- A file folder two hole punch with binding supplies
The file drawer is divided into three sections:
A) Employee Files – A folder for each employee labeled with their name, last name first
B) Payroll Processing – One file folder per payroll run and grouped into distinct subsections by quarter
C) Government Reports – One file folder per quarter and one file folder for the year-end reports
As I explain in the documentation process later, the above organization system will make sense and retrieval of information easier.
Electronic Filing System
As a prerequisite to continuing, I encourage you to read: Accounting File Structure located in the Accounting Systems and Technology page of the website. One of the directories within the electronic organization is called payroll. Within this directory create the following structure:
– Employee ‘A’
– Employee ‘B’
– Employee ‘C’
– Employee ‘D’
– Jan – March 20ZZ
– April – June 20ZZ
– July – Sept 20ZZ
– Oct – Dec 20ZZ
Notice the similarity to the paper system? Now the systems are ready for processing information.
From the human resources officer manager gather the following information (copies) and insert into the employee’s paper file and place an electronic copy (PDF) into their electronic file.
- Copy of W-4 from the current calendar year
- Copy of the state’s form for income tax withholding status
- Copy of legal mandates for withholding (court orders)
- Copy of benefit withholdings including retirement (benefits are explained in Lesson 35)
- Copy of most recent raise authorization
As each time sheet is received and authorized by the owner or manager the bookkeeper uses this to process the payroll – Lesson 31. After processing, scan the time sheet and name it as follows: Time Sheet – Employee ‘A’ – Period Ending Z-ZZ-ZZ
Place the physical document in the employee folder and the electronic copy in the employee’s respective folder. In addition, create a spreadsheet for each employee for each calendar year and insert into their respective electronic folder. Label the spreadsheet: Employee ‘A’ – Payroll 20ZZ.
Each tab of the spreadsheet is labeled individually as the year progresses for each payroll run, the payroll software allows the user to print a report (payroll detail report) for an employee. Simply export the report as an Excel spreadsheet tab to the respective employee’s spreadsheet. As the year progresses the employee’s spreadsheet will have one tab for each payroll. Label the tabs by payroll period as follows: PR 01-ZA-ZZ, PR 01-ZB-ZZ, PR 02-ZC-ZZ and so on.
At year-end the last tab is a summation page for all the payrolls and acts as the basis for reconciliation to the employee’s W-2.
Once the payroll run is complete including check signatures the bookkeeper is ready to document the respective run and the interim periods. Follow these steps:
Scan each employee’s information to a single file labeled: Employee ‘A’ Payroll Ending 01-ZZ-ZZ. In this file are the following:
- Time sheet with signature of owner/manager
- Employee’s payroll run detail report
- Copy of signed check
Place the paper set in the employee’s file. Notice that there are 3 sets of the payroll detail report:
- Paper copy
- An electronic copy in the file
- An Excel tab in the employee’s spreadsheet
Similar in nature to how each employee was individually processed; now the entire payroll run must be processed. The exception is that instead of one large file, scan or export the sets separately to the respective month. The following are file names and the corresponding information included:
A) Time Sheets 01-ZZ-ZZ – All time sheets with owner/manager’s signature
B) PR Authorization 01-ZZ-ZZ – Back in Lesson 30 and 31 I explained that the owner authorizes via signature the cutting of checks and disbursements from a report, this is where it ends up electronically; the paper version is stored in the file folders as identified above.
C) Final Detail Report 01-ZZ-ZZ – Similar report to what was authorized but it includes the check numbers for the respective checks.
D) PR Checks 01-ZZ-ZZ – All checks in numerical order with owner’s signature
E) Disbursement Report 01-ZZ-ZZ – Check disbursement and authorized tax payments
F) Tax Disbursement Receipts individually as follows:
- 941 Payment 01-ZZ-ZZ
- State Tax Payment ‘ID’ 01-ZZ-ZZ
- FUTA Payment 01-ZZ-ZZ
G) Benefit Program Disbursements and Schedules
H) Court Order Disbursements
I) Reimbursement Schedule (Copy to Employee’s File)
Naturally the paper copies are placed in the respective payroll processing month.
At the end of each month a spreadsheet tab is added for reconciliation purposes to an Excel file titled: PR 20ZZ Monthly Reconciliation. This report has one tab for each month of the calendar year and four tabs for the respective quarters. The goal for each month is to reconcile the monthly payroll processed as a summation report; this should match the payroll software program’s reports. Tie the gross wages to the trial balance (taught in a later lesson in this series); taxes to the respective employer matching taxes on the trial balance and finally vouch the information back to several employees for confidence that the information is accurate.
At the end of each quarter the payroll software will prepare a quarterly detail and summation report. Export the summary report as an Excel worksheet and insert into the payroll processing spreadsheet as a tab and in the quarterly electronic filing system. Name the tab: 1st Qrt Summation 20ZZ or 2nd Qrt Summation 20ZZ depending on which quarter is being processed.
The information should reconcile with the respective sums for all the monthly reconciliations. Once reconciled it is time to print the quarterly reports. Only copies of signed reports go into the quarterly paper files and signed copies are scanned into the quarterly file for the respective folder. The following are the respective final quarterly reports:
- Form 941
- Form 941 Schedule B and Final Payment
- State’s Income Tax Withheld Quarterly Reconciliation and Final Payment
- FUTA Reconciliation and Payment
- SUTA Reconciliation and Payment
- Benefits by Benefit
- Childcare Plans
- Life Insurance
- Legal Mandates
- Court Orders
The annual reports are covered in more depth in Lesson 34.
As with any bookkeeping function, there is some housekeeping functions to address. I encourage bookkeepers to back up the accounting structure regularly (every week) and send the thumb drive home with the owner. After three weeks, the owner should bring back the oldest thumb drive for reuse. In effect he keeps two thumb drives at home and one is in the office for electronic backups.
As for paper files, only keep active the current year files in the top drawer and in the second drawer keep the prior year files. The law requires no less than four years of payroll files on hand. I suggest five years of paper files plus the current calendar year; so there are six years of data available. Once the current year is moved down into the second drawer because of a year change, box up the prior calendar year and properly label the box. Place a destroy date on the box at least four years out. Thus, 2013 calendar year ends with the final report in 2014. The earliest destroy date is in the year 2018; I suggest a destroy date of June of 2019 for 2013; June of 2020 for 2014’s payroll and so on.
Retain electronic files indefinitely.
Summary – Payroll Compliance and Documentation
Section 31 of the Internal Revenue Code mandates employer responsibilities to accurately account for wages and withholding. Copies of records must be maintained for at least four (4) years. There are serious civil and possible criminal noncompliance ramifications for failure to properly account for economic activity. Use both a paper and electronic file structure to fully comply with regulation Section 31.6001. Act on Knowledge.
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