Top payroll and benefits compliance mistakes startups make (and how to avoid them)

Fast-growing startups often outpace their internal systems, especially when it comes to payroll and benefits. What starts as a simple setup for a lean team can quickly become a compliance tangle as you scale, hire across states, or prepare for fundraising.

For venture-backed startups, payroll mistakes aren’t just operational headaches. They can delay funding, trigger costly penalties, and complicate due diligence. The good news is that most risks are preventable with the right systems and processes in place early on.

Here are five common payroll and benefits compliance mistakes we see, and how to stay ahead of them.
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Why payroll compliance often gets overlooked 

When you’re focused on product, growth, and fundraising, it’s easy for back-office functions like payroll to fall to the bottom of the list. But small issues, if left unaddressed, can create bigger problems later, especially when investor scrutiny or legal requirements come into play.

The earlier you operationalize payroll and benefits, the fewer last-minute corrections you'll face under pressure.
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Mistake #1: Misclassifying employees

Misclassifying workers is one of the most common compliance issues startups face. These mistakes can lead to back pay, unpaid taxes, penalties, and legal exposure, especially in states with stricter labor laws.

Two issues that come most often:

• Treating full-time employees as contractors
• Misclassifying non-exempt (overtime-eligible) employees as exempt

Employees vs. contractors: Many states are cracking down on contractor misclassification, often viewing it as a tactic to avoid payroll taxes. If there’s any uncertainty, it’s safer to classify someone as an employee, and consult your payroll or HR advisor to be sure.

Not sure if a worker should be classified as an employee? Ask yourself:

• Do they work set hours (like 9 to 5)?
• Do you provide their equipment or tools?
• Are their tasks directed or supervised by someone at your company?

If the answer to any of these is yes, it’s likely the person likely qualifies as an employee. 

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Exempt vs. Non-Exempt: Starting January 1, 2025, the federal minimum salary for exempt employees increases to $1,128/week ($58,656 annually). Some states like California and New York have higher thresholds, and those take precedence.

To qualify as exempt from overtime, an employee must:

• Be paid on a salary basis
• Meet or exceed the minimum salary level
• Pass the FLSA duties test for one of six exemption categories. You can find the full list on the FLSA Worksheet.

This is one of those areas where a small oversight can lead to big compliance issues, so don’t hesitate to ask for expert guidance if you’re unsure.

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Mistake #2: Missing state and local registration requirements 

Hiring across state lines? Each new state comes with its own tax and compliance requirements. These can include:

• Income tax withholding
• State unemployment insurance (SUI)
• Local or municipal tax accounts
• Even school district tax obligations in some places

Failing to register in time can delay payroll, block benefits enrollment, and increase compliance risk.

Tip: Register for payroll tax accounts as soon as you hire in a new state. And remember: taxes are generally based on where an employee works, not where they live.

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Mistake #3: Missing payroll tax filings

Running payroll is just the start. You also need to stay on top of federal, state, and local filing schedules. Missing quarterly (Form 941) or year-end filings (W-2s, etc.) can trigger penalties or audits, especially for multi-state teams.

Make sure your payroll system or provider support:

• Timely filings and payments
• Multi-state compliance
• Clear accountability around who handles what

Mistake #4: Delayed or improper benefits enrollment

As your team grows, so do benefits expectations, and in some cases, legal requirements. Startups often trip up by:

• Offering benefits too late
• Lacking standardized onboarding processes
• Relying on a PEO that no longer fits their growth stage

At certain headcounts (sometimes as few as five employees), benefits like health insurance or paid leave become mandatory in some states. Make sure your setup can scale, and know when it’s time to transition from a PEO to an in-house model.

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Mistake #5: Treating payroll as ‘set it and forget it’

Payroll isn’t just a back-office function. It’s foundational to team morale, investor trust, cash flow forecasting, and compliance.

As your business grows, your payroll setup should grow with it. The right system should:

• Integrate with your accounting and HR tools
• Support multi-state or multi-entity operations
• Offer real-time visibility for both finance and people teams
• Support your growth plans

Tip: Choose a solution that fits your future business, not just where you are today. While smaller platforms may be cheaper now, they often don’t scale well as you grow.

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Check your setup

We created a Payroll and benefits compliance checklist for startups to help founders and operators avoid the most common mistakes. Use it to benchmark your current setup, flag gaps, and get ahead of compliance risks.

In summary‍

Payroll and benefits compliance don’t need to be overwhelming, but they do need to be intentional. With the right partner, systems, and workflows in place, you can avoid the common pitfalls we see across the VC ecosystem.
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The earlier you put the right habits and tools in place, the fewer surprises you'll face down the road. And if you’d like a second opinion or expert gut check, we’re here to help.