Would You Give an Employee a Payroll Advance?

One of the beautiful things about small businesses is that everyone in the organization becomes like family. There is a closeness that develops that is both comforting – and maybe distressing, too. When one member of your team is experiencing hard times, it can be difficult to maintain a professional distance. For instance, what would you do as a small business owner if one of your employees came to you asking for a payroll advance?

Your first inclination, as a friend, might be to agree and make it happen. But as a small business owner, is that the most appropriate action? There are some important things to consider before making a decision. The first is basic. But you have to ask yourself …

Is the transaction an advance or a loan?

If it would be an advance, it means the next check will be short. Does the employee have a plan to deal with that? In a West Sound Workforce blog, the writer says, “My experience is that oftentimes, taking an advance can be harmful for the employee, as their next paycheck is going to be short, and they need another advance to keep their heads above water. Pretty soon they’ve dug themselves into a hole they can’t crawl out of.”

You might think a loan, with regular payments from each subsequent paycheck might solve that problem. However, in doing so, a Foley & Lardner LLP articles tells us that “a company may subject itself to the disclosure requirements of the Federal Truth in Lending Act (TILA). In addition, there might be state consumer credit laws and wage assignment statutes in your state. State laws regulating payday lenders may apply and require licensing if the company takes a post-dated check from the employee.”

Sounds like a can of worms for the small business owner, doesn’t it?

Steps to take if you agree to a payroll advance

Right off the bat you need to establish a payroll advance policy. The policy will set forth what the company will do and what the employee can expect, or if payroll advances are available at all. There are many things to consider and include in the document that will apply to all employees, equally. For instance:

• Who is eligible? Is there a length of service requirement or criteria like the employee must be free of any disciplinary action (in a given time frame)?

• How often can advances be given? Remember, employers who has made more than 25 advances in the preceding calendar year might be subject to TILA regulations. Are the number of advances cumulative covering the entire organization or on a per-employee basis?

• What are the terms of repayment? Advances that are not completely repaid with the next check, or are spread out over several paychecks, especially if the maturity is 45 days or less, is considered a loan and may subject the business to TILA regulations. Always create a written agreement to ensure everyone party to the transaction is clear on what will happen. If an employee quits or is discharged, you might have a difficult time recouping the advance.

• Cover deductions and payroll taxes. According to West Sound Workforce, payroll deductions for payroll advances that bring their pay below minimum wage is acceptable – as long as the employee and employer agree IN ADVANCE AND IN WRITING. But the amount of payroll taxes and payment of deductions, such as insurance premiums must be considered.

• What about fees and interest charges? Your business would be providing cash to an employee prior to his earning it, which takes funds out of your cash flow before it would otherwise be expended. Does that give you the right to collect fees and interest? Yes, but be careful. There are laws that an employer cannot profit from such a transaction. In addition, you might be stepping into the loan area and subject yourself to TILA rules.

• Do you want to know the reasons for an advance? As a friend, the employee might offer an explanation for the need arising. Be careful! This can be a slippery slope setting the business owner up for discrimination charges later on. If you are enforcing any policy you establish fairly and equally in all instances, you will not appear to make judgments based on the reasons or situation.

Make sure your payroll records are accurate and follow the policy

This is where having a payroll processing service helps. You provide the process to be followed and the parameters, and a professional payroll service like The Payroll Department will take care of the procedure.

You will want to be able to account for taxes, advances, fees, and interest collected at the end of the year for accounting purposes. Be sure that included in your payroll processing is the ability to provide those reports. When The Payroll Department takes care of your payroll processing, you have one point of contact to ensure you get answers right away.

Make sure you are working with knowledgeable professionals to help guide you. Give Teresa Ray at The Payroll Department a call at 317-852-2568 today. Don’t leave this important issue to chance.

-Elaine of The Payroll Department Blog Team