How to Conduct a Wage and Hour Audit: A Step-by-Step Guide for HR and Payroll Teams

The DOL’s Wage and Hour Division recovered over $274 million in back wages for workers in fiscal year 2023 — and the majority of those recoveries came from small and mid-size employers in food service, healthcare, hospitality, and retail. If you haven’t audited your wage and hour practices recently, there’s a reasonable chance you’re carrying liability you haven’t identified.

A wage and hour audit doesn’t require an attorney or a formal engagement. It requires methodical review of the highest-risk areas in your payroll and HR operations. This guide walks through the core audit components so your team can identify and correct issues before they become claims.

Step 1: Audit Employee Classifications

Start with exempt vs. non-exempt classification. Pull a list of every employee currently classified as exempt from FLSA overtime. For each one, confirm two things: the salary basis test (are they paid a fixed salary of at least the applicable threshold with no improper deductions?) and the duties test (do their actual job duties meet one of the FLSA exemption categories?). Both tests must be met for the exemption to apply — salary alone isn’t enough.

The administrative exemption is the most frequently litigated. It requires the employee’s primary duty to be office or non-manual work directly related to the employer’s general business operations, and it must include the exercise of discretion and independent judgment with respect to matters of significance. An HR coordinator who follows established procedures and escalates decisions to a manager may not qualify. An HR manager who designs policy, makes independent hiring decisions, and has authority to commit the employer may. The line isn’t always clear — if you have employees classified as administrative exempt based primarily on their job title rather than a duties analysis, that’s an audit flag.

Independent contractor classification is the second major area. For each 1099 worker your company uses regularly, apply the FLSA economic realities test: does the worker depend on the company economically, or do they genuinely operate an independent business? Factors include the degree of control over how work is performed, the permanency of the relationship, whether the work is integral to the company’s business, and the worker’s investment in their own tools and equipment. Workers who do the same work as employees, on the company’s schedule, with company equipment, and for the company as their primary client are likely employees regardless of what the contract says.

Step 2: Review Overtime Calculations

Pull a sample of payroll records for non-exempt employees who worked overtime during the past six months. For each, verify that the overtime rate was calculated on the correct regular rate of pay — not just the base hourly wage. The regular rate must include shift differentials, non-discretionary bonuses (bonuses tied to hours worked, productivity, or performance that employees expect to receive), and most other compensation. If your overtime calculations have been running on base wage only for employees who also receive shift premiums or production bonuses, that’s a systematic error across every overtime check for every affected employee.

Also check your workweek definition. Overtime under the FLSA is calculated per workweek — a fixed, regularly recurring period of 168 hours (seven consecutive 24-hour periods). The workweek can start on any day, but it must be consistent and can’t be changed retroactively to reduce overtime. If your payroll system is calculating overtime on a pay-period basis rather than a workweek basis, you may be under-calculating overtime for employees whose hours aren’t evenly distributed across the pay period.

Step 3: Audit Time Records for Off-the-Clock Work

Review time records for patterns that suggest off-the-clock work. Specific things to look for: clock-in times that consistently match shift start times exactly (suggesting employees aren’t recording pre-shift work), clock-out times that consistently match shift end times exactly (suggesting post-shift work isn’t recorded), meal break deductions that appear for every employee on every shift regardless of whether breaks were actually taken, and significant gaps between clock-out and closing times for employees who have closing responsibilities.

Talk to frontline managers about what actually happens at shift start and end. If the honest answer is “people have to set up before they clock in” or “there’s always 10 minutes of closing work after people clock out,” that’s compensable time that isn’t being paid. The FLSA doesn’t require that employees initiate a complaint — if the employer has reason to know work is being performed, the time is compensable regardless of whether employees asked to be paid for it.

Step 4: Review Tipped Employee Practices

For employers using the tip credit, audit three specific areas. First, are tip credit disclosures being given to every tipped employee before the credit is applied? The FLSA requires that employees be informed of the tip credit amount, the cash wage, and the tip credit provision before you apply it. Second, is the tip pool limited to eligible employees — front-of-house servers, bussers, bartenders, and other traditionally tipped employees? Managers, supervisors, and kitchen staff (in non-tip-credit situations) cannot participate. Third, do employees’ tips, combined with the cash wage, always equal at least the minimum wage for every workweek? If not, the employer must make up the difference — and that calculation must happen every workweek, not averaged across pay periods.

Step 5: Check Recordkeeping Completeness

The FLSA requires employers to maintain specific records for non-exempt employees for at least two years (some records three years). Confirm you have complete records of: hours worked each day and each workweek, regular hourly pay rate, total daily and weekly earnings, overtime earnings, all deductions from wages, and total wages paid each pay period. For tipped employees, add records of weekly tips reported by employees and the tip credit claimed. Gaps in these records create presumptions against the employer in wage disputes — if an employee claims they worked more hours than the records show, the burden shifts to the employer to rebut that claim with accurate records.

Netchex maintains timestamped time and attendance records, pay rate history, overtime calculations, and deduction documentation within a single system — making the records-retrieval portion of a wage and hour audit manageable rather than a multi-day reconstruction exercise. Talk to a Netchex consultant about payroll audit readiness for your team.

Frequently Asked Questions

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