A primary goal of any internal payroll audit is confirming that every dollar paid goes to a real, active worker at the proper compensation rate.
- Reconcile Active Payroll Roster Against HR Records: Compare the active employee list in your payroll platform against HR onboarding records, building badge logs, and IT system directories. Immediately investigate any unfamiliar names, duplicate Social Security numbers, or shared bank account numbers across multiple employees (a classic indicator of "ghost employee" fraud).
- Audit Terminated Employees: Confirm that every worker terminated during the review period has a termination date recorded in payroll and received zero regular wages after their separation date.
- Verify Pay Rates and Salary Changes: Pull a sample of employees (or 100% for smaller teams) and match their current hourly rate or annual salary in payroll against signed offer letters, promotion notices, and merit increase approvals.
Phase 2: FLSA Classification and Timekeeping Compliance
Wage-and-hour lawsuits remain one of the most common legal threats facing US employers.
- Audit Exempt vs. Non-Exempt Classifications: Review all salaried exempt employees to verify they meet both the federal FLSA minimum salary threshold (and higher state salary thresholds in states like California, New York, and Washington) and the primary job duties tests (Executive, Administrative, Professional, Computer, or Outside Sales).
- Test Overtime Calculations: Select a random sample of non-exempt employee timesheets and manually recalculate overtime pay. Confirm that overtime was computed on a strict seven-day workweek basis, included shift differentials and non-discretionary bonuses, and respected daily overtime rules in applicable states.
- Check Meal and Rest Break Compliance: Review timecards for missed meal punches, automatic meal-deduction overrides, or off-the-clock work patterns before or after scheduled shifts.
- Review Independent Contractor (1099) Engagements: Inspect vendor payments to ensure long-term 1099 contractors have not drifted into W-2 employee roles under IRS control guidelines or state ABC tests.
Phase 3: Tax Withholding, Benefits, and General Ledger Reconciliation
- Reconcile Payroll Registers to Form 941 and State Returns: Compare gross wages, taxable Social Security/Medicare wages, and withheld income taxes across your internal payroll summaries against filed quarterly Form 941 returns and state withholding filings.
- Audit Pre-Tax Benefit Deductions: Verify that employee deductions for medical insurance, HSAs, FSAs, and 401(k) plans match current enrollment elections and have not exceeded annual IRS statutory contribution limits.
- Verify Tax Deposit Timeliness and Bank Reconciliations: Match every payroll tax liability accrued in your payroll system against actual EFTPS and state tax portal debits on your payroll bank statement. Reconcile the payroll clearing account in your general ledger to ensure the balance nets to zero after each pay cycle.
Phase 4: Document Findings and Remediate Errors
- Log Discrepancies in an Audit Remediation Tracker: Record every error discovered, the root cause, the affected employees or tax periods, and the corrective action required.
- Process Retroactive Back Pay or Tax Amendments: Issue any owed back wages promptly to limit FLSA liquidated damages exposure, and file Form 941-X or state amended returns if historical tax filings require adjustment.