On-demand pay, also known as earned wage access and instant pay, allows employees to access their wages as they earn them, rather than waiting until a regularly scheduled pay date. They can opt for daily pay or accumulate their earnings for a later payout.
On-demand pay is not the same as a payroll advance. The former lets employees request their earned money in the ongoing pay period, while the latter involves asking for a portion of their future paycheck now.
Key Takeaways:
- On-demand pay can be a great way to provide workers with real-time access to their wages
- On-demand pay can lead to tax liabilities for both employers and employees
- Understanding and mitigating risks is paramount to effective on-demand payroll processes
How On-Demand Pay Works
Typically, the on-demand pay process flows in this order:
- Employee works their regular schedule: To start, the employee works their regularly scheduled hours. These hours are tracked and recorded, just like any other payroll process.
- Employee decides how much money they need from their paycheck: An employee decides how much of the wages they’ve earned since their last paycheck they’d like to withdraw. Keep in mind that some on-demand pay providers have limits as to how much employees can withdraw of what they’ve earned—50% of earned wages is common. There are also sometimes limits on how much can be withdrawn per pay period or per day. Most on-demand pay apps will show the daily balance available for withdrawal after each workday. Some will even send the employee an alert with a prompt for them to withdraw funds.
- Employee makes a withdrawal request and the provider sends the money to their account: Once the employee requests the amount they want, the provider sends the funds to their account, as long as it doesn’t exceed the balance they’ve earned for the period. For instance, if an employee earns $1,000 per week, and they’re closing out the first half of the week, they should have $500 available to withdraw. If they request $600, their request will be denied, and they’ll be forced to enter a lesser amount. In some cases, this request will need to be approved by the employee’s manager, the HR team, or both for accuracy and compliance with your company’s policy.
- Employee receives funds: The employee receives the funds they requested into an account of their choosing. There may be a transfer fee deducted, especially if sending the money to a bank account. Some providers will deposit funds to money management apps like Cash App for free.
Other fees could include a subscription fee, which may be based on a time period; a transaction fee, which may be based on the number of employee payments; or a merchant fee, which can be a percentage of an employee’s payment.
Some examples include DailyPay, charging workers up to $2.99 for an instant transfer and up to $1.99 for a next-day transfer, and Branch, charging anywhere from $2.99 to $4.99 depending on the amount to be transferred.
- Employer processes payroll: At the end of the pay period, you’ll be ready to process payroll; at this point, you can deduct any amounts the employee withdrew from their total net pay amount to determine how much of their remaining funds you owe them.
Tip: It’s better to go through a payroll or on-demand pay provider, like Gusto, than to try to manage this process yourself. These providers typically have limits in place (like the 50% of earned wages limit we discussed above) to protect your company against potential federal labor violations.
All employees must receive at least minimum wage (currently $7.25 per hour per federal law) for the pay period and any overtime pay they’re eligible for. Doing payroll calculations manually or on your own can make it hard for you to keep track of the actual taxes owed, hourly rate, etc.
Types of On-Demand Pay
Having increased in popularity, there are many on-demand pay options available. Here are some of the most common:
- Instant pay: With this model, employees have the ability to access their earned wages instantly, often through a mobile app. This can be especially beneficial for employees facing unexpected expenses or financial emergencies. However, instant pay may involve transaction fees on both ends.
- Daily pay: This model provides workers with daily financial flexibility and can be particularly appealing to hourly workers. Some businesses choose to limit the percentage of daily earnings that can be accessed to ensure employees still have a substantial paycheck at the end of the pay period.
- Partial pay: Through this model, employees can access a certain portion of their earned wages before payday. This could be a fixed percentage or a flat dollar amount. This can give employees increased financial flexibility while also encouraging budgeting and financial planning skills.
On-Demand Pay vs Traditional Payroll: How Are They Different?
Both on-demand pay and traditional payroll are designed with the same fundamental goal in mind: to compensate employees for their work. Both systems must comply with federal and state wage and hour laws, and both require accurate record-keeping to ensure correct payment of wages and employment taxes.
However, the main difference between these payroll systems lies in the timing of wage payments, leading to more precise distinctions, like administrative complexity. On-demand pay can be more administratively complex. Depending on the type of system you choose, you may need to calculate and process wages daily, which could increase administrative tasks and costs. This comes on top of the regulatory requirements and headaches discussed earlier.
Laws Affecting On-Demand Payroll
There are several regulations governing on-demand payroll that are being considered. Businesses that offer on-demand pay should be aware that, regardless of whether Congress makes these changes, they should currently be using either a daily or a miscellaneous payroll period and withholding and paying employment taxes on employees’ wages every day. This is in line with existing federal employment tax laws.
If businesses don’t properly withhold or pay these taxes, they could face civil and criminal penalties. Check whether you’re following current tax laws and think about what changes you might need to make if Congress accepts the Department’s suggestions.
When Wages Are Considered Paid
Because on-demand payroll is just starting to become more popular, there are some outdated state laws that haven’t yet caught up. If you opt to offer this benefit to your employees, we encourage you to research your state laws and, if possible, speak with a legal expert because things can quickly get complex.
The constructive receipt doctrine of the Internal Revenue Code says that wages are considered paid once they’re available for withdrawal, no matter if employees actually take the money out. When employees receive their wages, employers must withhold taxes and deposit them. Usually, this happens on payday. But if on-demand pay is seen as being paid the day employees ask for it, employers might mess up their tax duties if they stick to their regular schedule.
2023 Greenbook
In the annual Greenbook, the Treasury Department talked about this issue. They’re worried some businesses are using tax loopholes linked to when wages are paid and taxes are withheld and deposited. Based on the old tax rules, they think:
- Employees with on-demand pay may be seen as always having received their wages.
- Businesses offering on-demand pay should use daily or miscellaneous pay periods.
- These businesses should also hold back and pay taxes on wages every day.
But the Department knows it’d be a big job for businesses to change their payroll systems and make deposits daily, so they suggested Congress tweak some tax laws to handle issues with on-demand pay. They want Congress to define on-demand pay, consider its payroll period weekly regardless of when wages are accessed, clarify it’s not a loan for tax purposes, and create special deposit rules.
Pros & Cons of On-Demand Pay
On-demand pay comes with several advantages and disadvantages for both employers and employees alike. Click through the tabs for some of the main issues to consider before making a decision.
Is On-Demand Pay Right for Your Business?
It ultimately depends on your business. As a small business owner, there are several key factors to consider:
- Employee needs: Consider the financial needs of your employees. If many of your employees face financial stress due to the timing of their pay, on-demand pay may be a beneficial option.
- Business resources: Consider your resources. Do you have the capacity to manage the increased administrative tasks that come with on-demand pay? There are third-party providers who can manage this for you, but this will come at a cost.
- Costs: On-demand payroll often involves additional fees, which can be paid either by the employer or the employee. Be transparent with your employees about any costs associated with accessing their pay early.
- Regulations: If it sounds like we’re beating this topic into the ground, it’s because it’s vital. Stay up to date with wage and hour laws in your state and at the federal level. As regulations around on-demand pay evolve, ensure your business remains compliant to avoid potential penalties.
Frequently Asked Questions (FAQs)
Depending on the type of on-demand pay system you use, there may be little to no impact on your cash flow. Some third-party providers front the money for early wage access and then recoup the funds on your regular payroll date. However, if you choose to fund early wage payments directly, you’ll need to ensure adequate cash flow.
Generally, yes. However, the specifics may depend on the terms of the on-demand pay service provider, your payroll system, and your state and local labor laws.
It may and it certainly requires careful management. You must ensure accurate record-keeping, timely tax withholdings and payments, and compliance with ever-evolving regulations around on-demand pay.
Bottom Line
On-demand pay can be a positive benefit to your current employees and help with recruitment of new employees as it provides more financial flexibility and freedom. Providing financial literacy resources, evaluating your current people operations process, and thoroughly researching your on-demand pay options will help make the process seamless for both your participating employees and your employees tasked with the implementation.
