Giving your workers a payroll advance simply means offering them early access to their paychecks (generally due to an unforeseen event) with agreed-upon conditions. It basically functions as a short-term loan that employees repay with future paycheck deductions. Before offering staff this option, you should carefully consider legal regulations, taxes, and alternatives.
Several laws affect payroll advances, but they are subject to change, so it’s essential to check them at least a couple of times a year if you issue advances.
What to Consider Before Issuing Payroll Advances
Payroll advances can help employees and garner goodwill for your company. Before you act, however, it’s important to consider the implications.
The first item to consider is the stress that a payroll advance may place on your payroll team. If you have a small payroll team, payroll advances may become overwhelming. This is why many companies simply don’t offer them.
Each advance made to an employee requires time-consuming and complex tracking. You’ll need to ensure all state and federal taxes are accounted for and ensure proper recordkeeping. If not managed correctly, your company risks noncompliance violations.
Should you withhold payroll taxes from a payroll advance? Since a payroll advance is essentially a short-term loan, you won’t need to withhold payroll taxes from it, and your employee should pay you back in full. You’ll continue to process payroll as usual, withholding taxes and the agreed-upon amount from each paycheck until the debt is fully paid.
Federal law prohibits paycheck deductions that would reduce an employee’s pay below the minimum wage—but payroll advances are an exception. If an employee owes your company money because of a payroll advance, then your company can withhold money to pay back the advance at rates that may reduce the employee’s pay below the minimum wage. Note that this is a federal exception, and some states do not allow this practice, so check your state and local laws.
Compliance tip: Companies cannot profit from payroll advances to employees. You can add administrative fees to cover any paperwork, recordkeeping practices, or bank charges, but you cannot profit from the advance, so keep any charges low.
Under federal law, there are only certain reasons you can deduct pay from an employee, like taxes and benefits. For any reason not provided for under federal or state law, you must get the employee’s consent, in writing, before initiating any deduction.
For more specific information about the regulations for payroll advances in your state, check out our state payroll guides. They cover everything from minimum wage to labor laws and even provide in-state resources for any additional guidance you need: