Blogs

No matter how good your payroll process is, occasionally, you may accidentally overpay an employee, making a correction necessary. Most overpayments require only small corrections, but some are more complicated. Each situation is unique, and we can’t address every possible scenario in an article. However, some of the factors at play are similar in nature and we can give you a place to start. Please be sure to contact Employers Council and a tax expert.

Federally, the Department of Labor (DOL) treats an overpayment of wages the same as a loan or an advance to an employee, meaning an employer can withhold the full amount overpaid even if it takes an employee below minimum wage. Employers must remember that state laws may prevail on the issue of making a deduction from an employee’s pay. Arizona, Colorado, Idaho, New Mexico, and Utah all have statutes prohibiting an employer from making a deduction that causes an employee’s wages to fall below minimum wage. In addition, those six states and California require an employee to authorize any deductions in writing. Wyoming has no relevant statute, and the federal rule applies.

If the overpaid employee is still active, ask yourself how much to withhold. What will the impact be on the employee if you withhold all at once? Would you prefer to take payments? Doing so may be better for the employee, but there is a risk that they may leave before the overpayment is fully repaid. Can the company afford to lose the employee? Once a plan is in place, there are additional specific questions.

One area is tax concerns. Employers Council does not provide in-depth tax advice. Always consult a certified public accountant (CPA) and/or tax advisor with payroll expertise before making any tax decisions. In remedying an overpayment, one concern is how to manage taxes. Withholding and employment tax concerns for repayment depend on the tax year of the repayment according to the claim-of-right doctrine, as follows:

• Repayment in the year of the overpayment.The amount repaid by the employee is treated similarly to a pretax deduction—the repayment reduces federal income, Social Security, Medicare, and Federal Unemployment Tax Act (FUTA) taxable wages in the payroll period of the repayment. But if a quarterly tax form has been filed/paid, an employer may need to do a correction. See a CPA.

• Repayment in the year(s) subsequent to overpayment.Under the claim-of-right doctrine, the amount repaid is treated as an after-tax deduction that is posted to an employee receivable account so that current-year taxable wages, withholding, and employment taxes are not affected by the repayment. The repayment is generally equal to the overpayment less FICA tax withholding. The alternative is for the employer to repay the gross overpayment, and the employer issues a refund of FICA tax on the amount of the wages repaid. In such situations, employees must certify they have not and will not claim a FICA tax refund on their personal tax returns. (R.C. §§1341, 67(b)(10); Pub. No. 525)

Different questions arise if the employee leaves or becomes no longer active. In many cases, it may become difficult to recoup the overpaid wages. Actions should be taken quickly, especially in situations involving large amounts of money. 

• First, a demand for repayment should be made, preferably using legal counsel.

• In matters of large amounts, an employer should consider filing charges for theft. Filing charges may be required if pursuing legal claims or insurance.

• A claim can be filed in court depending on the amount, usually either in small claims court or local district courts.

• Immediately look into any insurance policies the company may have and contact the carriers.

• Finally, depending on success in reclaiming the lost wages, discuss how to manage loss with a CPA.

These are just some of the questions that may arise. Frequent audits of the company payroll system, along with identifying weaknesses in the process, may go far in managing to avoid overpayments. If you have any questions, please email the Employers Council Member Experience team at info@employerscouncil.org.