Successfully navigating emerging payroll reporting challenges and compliance

The landscape for payroll reporting is constantly evolving, representing an ongoing challenge for finance and human resources leadership. Companies must incorporate lessons learned from previous years and understand changes for the coming year to maintain state and federal compliance while increasing the efficiency and accuracy of payroll reporting processes. 

RSM US Partner Anne Bushman, along with Senior Directors Peter M. Berard and Dominique Wadhwa and Senior Manager Jen Claud-White, recently discussed how to understand payroll tax obligations to remain compliant across various jurisdictions and how to address necessary changes based on federal, state and international requirements during RSM’s recent Top payroll considerations webinar.

Recent regulatory changes that may affect payroll

State-sponsored paid family and medical leave (PFML) programs and state disability insurance (SDI) programs are both becoming more common, providing support for employees when they need it the most, with paid time off for various qualifying reasons that can vary by state.

For example, PFML may be utilized to care for or bond with a new child after birth or adoption or care for a family member’s medical condition, while a SDI program provides partial wage replacement for employees who experience an unexpected absence due to a non-work-related illness or injury. 

Several specific nuances apply regarding how PFML programs are designed and how contributions are determined depending on the state. However, IRS Rev. Rul. 2025-4 provides guidance on the federal income and employment tax treatment of contributions and benefits paid under state-administered PFML programs and addresses reporting requirements. 

Evolving worker classification guidelines

Worker classification is an issue that arises within many companies, determining whether an engaged individual should be classified as an employee or a contractor. This determination is important to understand a company’s obligation to report and subject compensation paid to a worker to payroll taxes (i.e., federal, state and local income tax withholding, Social Security and Medicare tax).

Whether a worker would be properly classified as an employee or a contractor is facts and circumstances determinative. To help with this contractor-versus-employee decision, the IRS has amended its previous list of 20 common law factors of Revenue Ruling 87-41 to three basic premises: behavioral control, financial control and the relationship of the parties. By evaluating these factors, companies can effectively determine how workers should be classified. 

While the classification guidelines are very specific, there are some professional professions that still require a weighing of the specific facts and circumstances of their engagement, but may lean toward contractor classification being proper (e.g., long-haul truckers and owner-operators; statutory nonemployees like direct sellers and real estate agents; statutory employees including full-time insurance sales agents; and certain licensed professionals such as accountants, attorneys, physicians, etc.).

In addition, workers may have different classifications between the IRS, the United States Department of Labor and state departments of labor. This challenge can emerge because some states follow the common law test and the common law factors, but other states will follow what’s known as the ABC test or a version of it.

The ABC test is a legal standard used in some states to determine if a worker is an employee or an independent contractor. It's a three-pronged test, and a worker must meet all three criteria to be classified as an independent contractor.

“Nothing is ever black and white in taxes,” says Berard. “So, you need to be mindful that, as an employer, you want to make sure that you're properly classifying your employees so that you're not, if audited, held liable for your Social Security, Medicare and taxes that are under withheld, as well as unemployment, state unemployment insurance, and the penalties and interest that are associated.”

With some ambiguity in worker classification guidelines, errors can occur. However, the IRS has created multiple programs that employers can consider to mitigate historical exposure. The Voluntary Classification Settlement Program (VCSP) is an attractive option, enabling employers to pay off obligations—potentially for cents on the dollar—based only on compensation paid for the most recently closed calendar year if certain criteria are met. These criteria include:

• Consistently treating the workers to be reclassified as independent contractors and filing all required Forms 1099 for the workers for the previous three years
• Cannot currently be under federal or state audit for worker misclassification or an employment tax issue
• Compliance with the results or not currently contesting the classification in a previous worker classification audit

With the VCSP, no interest or penalties are added, and the IRS agrees not to audit the organization for any periods prior to the time reported.

In addition, section 530 of the Revenue Act of 1978 provides relief with similar requirements to the VCSP. A company must have reporting and substantive consistency in terms of reporting individuals consistently as independent contractors over the years. Additionally, a company must have a reasonable basis for why they treat someone as a contractor versus an employee. A revenue ruling and a revenue procedure released by the IRS earlier this year outlined certain liabilities for employment taxes and provided clarification on how to claim relief under section 530.

Beyond the VCSP and section 530, companies can also get misclassification relief with the Classification Settlement Program, where an employer is under examination and IRS examiners are able to offer a settlement using a standard closing agreement.

Finally, early referral to the appeals program is also available as relief. When a taxpayer is under audit, the taxpayer may request a transfer of a developed or contested employee tax issue to be referred to IRS appeals.

Where an employee works matters

Nonresident income tax withholding is still a major issue for many companies, with employees working remotely or in hybrid work situations. The general rule for the withholding of state income taxes is that companies need to withhold for the state where someone performs services. However, some exceptions can emerge.

For example, state de minimis thresholds only require withholding state income tax if the person has worked a number of days, earned a certain amount of wages or reached another threshold. Additionally, reciprocity agreements are in place, typically between neighboring states or within the same region, where an employer may only withhold the income tax of the resident state for an employee if they have provided a certificate of nonresidence to their payroll department.

Managing multistate and nonresident employee compliance can be very complex, due to varying state tax laws and regulations. Some key points to consider include:

Wage reporting for an international workforce

Managing payroll for an increasingly mobile international workforce involves several key factors that influence U.S. payroll reporting and withholding. Understanding these factors is crucial for maintaining compliance and avoiding potential tax issues. Issues to monitor include:

Global mobility program managers are expanding employee support to include nontraditional assignments, such as business travelers, cross-border commuters, rotator employees and global transfers. Historically, organizations have debated which cross-border employment requires special handling, often assuming that complexity only applied to traditional long-term assignments. However, variables such as travel patterns, cost allocation, employment and residency status can obscure all these distinctions.

Managing international payroll compliance: “Managing international payroll compliance is like orchestrating a symphony,” says Wadhwa. “You need to confirm that tax compliance efforts across multiple jurisdictions are harmonized, preventing double taxation, and that bonuses and equities are tracked diligently to adhere to local reporting laws. A host shadow payroll may need to be implemented to ensure compliance with local tax and social security regulations while avoiding disruptions to the home country payroll.”

Reporting for nonresident employees: Nonresident employees on short-term assignments may be overlooked for host country tax liabilities and assignment-related benefits. It is crucial to confirm applicable tax treaties and requirements for exemptions. If assignments extend, benefits such as per diems and housing reimbursement may become taxable in both the home and host countries, resulting in unforeseen liabilities.

Tracking travel data: When mobile employees are not tracked for potential trailing wage and tax reporting compliance, it can result in surprise tax liabilities and lost tax planning opportunities. Organizations may face outstanding taxes, interest and penalties.

To mitigate these risks, organizations must actively embrace and monitor global mobility. Leadership plays a critical role in driving awareness and fostering collaboration between payroll, HR and global mobility teams to ensure alignment, compliance and strategic workforce planning.

Technology plays a key role in tracking and managing mobility when you have a larger volume of cross-border employees, with human resources information system (HRIS) and payroll platforms enabling targeted identification of mobile employees. Regular reviews of potential, active and former assignees help organizations understand the status of trailing liabilities.

Managing assignment-related benefits: The tax treatment of assignment-related benefits, such as relocation, housing, host tax liability, per diems, home leave and short-term travel expenses can vary significantly between the U.S. and foreign tax jurisdictions. In the U.S., these benefits are generally considered taxable unless specifically excluded by the Internal Revenue Code. For example, relocation expenses and housing allowances are typically taxable, but certain travel expenses may be exempt if they meet the criteria for temporary short-term assignments under U.S. tax law.

Determining wage reporting and withholding: Reporting and withholding for cross-border employees involves several key steps, including:

These steps ensure compliance with both U.S. and host country tax laws, minimizing the risk of penalties and ensuring accurate tax reporting.

Global payroll excellence: Streamlined processes and collaboration

Understanding international payroll reporting compliance and implementing efficient global processes are crucial for business success. An effective reporting foundation encourages compliance with constantly evolving local regulations, prevents penalties and fosters trust among employees and stakeholders. Effective global compliance not only enhances operational efficiency but also safeguards the company’s reputation. Companies can achieve global payroll excellence by focusing on three key areas:

Is it time for a payroll health check?

With quickly evolving payroll demands and regulatory standards, every organization should undergo a regular evaluation of critical processes to evaluate compliance and potential opportunities for improvement. In some cases, you may need a quick look at your payroll tax process to confirm alignment with relevant state, local, federal and international guidance, or maybe you want to determine if you have any gaps in processes or documentation that could create a larger pain point if not proactively addressed. 

A payroll health check from a qualified advisor can provide an unbiased review of your payroll and payroll tax processes and quickly identify any potential concerns or vulnerabilities. A health check should focus on common areas of risk and opportunity, including:

• Payroll reconciliation process
• Notice/audit resolution process
• Earnings and deduction code
• Worker classification
• Payroll process review and development
• Fringe benefit tracking
• Multistate and remote workforce taxation
• Transaction tax ramification   

The takeaway

Establishing an effective and compliant payroll reporting framework is an ongoing, complex journey that requires strategy, planning, cross-functional collaboration and a global perspective. With these elements in place and periodic reviews of processes, reporting and compliance, your payroll function can operate seamlessly and quickly adapt to new regulatory requirements regardless of where your employees live and work.