Mistakes happen. But be careful about how you correct them when it comes to payroll. As the philosopher Francis Bacon warned us, “The remedy is worse than the disease.” As it applies here, your remedy may be breaking the law. This can result in fines, penalties, and bad publicity.
As a business owner, you need to correct the mistake of overpaying an employee while staying compliant with federal and state laws. Can you simply deduct the overpaid amount from an employee’s future wages? And how do you prevent these errors from happening again?
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Common Reasons Employers Accidentally Overpay Employees
1 – Data Entry Errors
The person manually entering payroll data mistakenly adds extra hours or pay.
2 – Time Clock Errors
This can happen when you add hours to an employee who is missing time clock punches. A couple of examples include:
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An employee doesn’t clock back in after their lunch break
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Someone on your team has to manually adjust hours. This can lead to data entry errors.
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An employee forgets to clock out at the end of their shift. This can make it appear as if the employee worked overnight.
Asure provides Time and Attendance solutions to prevent costly errors. Asure’s Time & Attendance solution enables employers to easily manage time collection, accruals, and employee schedules while staying compliant with FLSA and overtime laws.
3 – Miscalculations
Employees may get overpaid due to miscalculating their withholding or overtime pay.
Can Employers Take Back Wages From an Overpaid Employee? (Beware of Compliance Issues)
Yes, but there are strict rules and laws that vary from state to state. According to attorney Sachi Clements, employers can deduct the full amount of overpayments from employees under the Federal Labor Standards Act (FLSA). And that’s even if doing so would bring the employee’s wages below minimum wage for the pay period.
As an employer, you can do this without consent and without notice – BUT – this is federal law. Your state law may have less leeway, and this stricter state law would take precedence. For instance, in New York state, employers must first notify the employee in writing of the amount of the overpayment, the amount of the deduction, the date the deduction will occur, and any procedures the employee may use to challenge the deduction.
California is more stringent. The state requires an employer to notify the employee and get the employee’s written authorization before making the deduction. In New Hampshire, the law firm of Douglas, Leonard, and Garvey cites RSA 275:48, I (d)(4), “an employer can only recover an accidental overpayment of wages from an employee by way of a voluntary agreement that must be memorialized in writing. The statute allows the employer to recoup the overpayment not in a lump sum but instead through deductions from the employee’s paychecks.” And there are further restrictions on how an employer may recover wages in this state.
How Long Does an Employer Have to Reclaim an Overpayment?
It depends on your state’s law. Here are some examples:
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California: an employer has three years.
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Massachusetts: an employer can recover overpayments in the eight weeks prior to the issuance of notice and may make deductions to recover overpayments for a period of six years from the original overpayment.
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Michigan: an employer has six months from the time of the overpayment to collect.
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New York: an employer can collect overpayments up to 8 weeks prior to a notification to an employee with a maximum of six years to do so.
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Washington state: an employer has 90 days of overpayment to take action.
Tax Implications
Let’s say an employee pays back the overpaid amount in a subsequent year from when it took place. You may need to issue a corrected W-2 or W-2c. And you may need to review your taxes and file amendments. Consult your accountant or an HR expert at Asure.
A Creative Solution to Employee Overpayment
You and your employee may find it mutually beneficial to agree to allow the worker to keep the excess pay and instead deduct future PTO (Paid Time Off) to make up for the overpay.
How Can a Business Owner Collect Overpayment Made to a Former Employee?
Business Owners have a couple of options. They can:
1 – Contact your former employee, explain the situation, and request that they return the money.
Or
2 – If the former employee declines, you may need to consider legal action or drop the matter.
How Can Employers Prevent Overpaying Employees?
Employers have a few steps they can take.
1 – Add up hours at the conclusion of each pay period and review for accuracy.
2 – Issue a written policy that employees must check their pay and immediately report any errors.
Then explain the process for what happens if they are accidentally overpaid. You might consider including this in your Employee Handbook. Did you know? In our 2023 HR Survey of over 2,000 small and midsize businesses, we found that 80% of Fast Growing companies have an Employee Handbook updated in the past 12 months. And nearly 40% of companies that didn’t grow last year do NOT.
3 – Consider an outsourced payroll provider.
Payroll providers such as Asure have proven processes and seamless integrations with Time & Attendance software to reduce errors. Asure automates the complex management of wages, direct deposit, tax codes, and all payroll and tax functions to experts who ensure you remain compliant.
Conclusion
When faced with the situation of overpaying an employee, employers must handle the correction carefully. Be sure you are complying with federal and state laws. In many states, the regulations are more stringent, and it’s those rules you must follow. So, familiarize yourself with the specific laws in your state before taking any action. The time limit for reclaiming overpayments also varies by state.
Correcting an overpayment incorrectly can lead to legal consequences, fines, penalties, and damage to a company’s reputation. Consult with an accountant to navigate the tax implications of reclaiming overpaid wages. Implementing preventive measures such as regular review of payroll accuracy, establishing written policies for employees to report errors, and considering outsourcing payroll to a reliable provider like Asure can help minimize the occurrence of overpayments.