Payroll Advances: Good Idea or Big Mistake?

Workers who run into short-term financial problems are known to ask their employers for payroll advances. How should employers respond? Are payroll advances a good idea, or are they a big mistake?

There is no blanket rule that applies to every situation. Each employer has to decide individually whether offering payroll advances is a viable benefit they are willing to provide. In making such a decision, management has to consider more than just the bottom line. There is a lot that goes into payroll advances from both legal and administrative standpoints.

Are payroll advances a good idea or a big mistake for your company? That depends on how the following three things apply to your situation:

1. Regular Payroll Processing

Employers choosing to provide payroll advances must account for them in their payroll reporting. According to BenefitMall payroll services, this often dictates making a few minor changes to payroll software. For example, a new category of income must be added to account for the money advanced to employees. Any amounts entered under this category are not taxed at the time the advance is made.

Conversely, a new deduction must also be created to account for repayment of the advance. Whether the entire advance is deducted from the next paycheck or addressed over multiple pay periods, payroll software must account for it. All amounts entered under this category will be accounted for as a taxable amount. The idea here is to tax earnings as they are earned – not when they are advanced.

2. Payroll Advance Policies

BenefitMall recommends employers develop written payroll advance policies before even thinking about granting an employee request. Here’s why: while employers are not required to offer payroll advances, the law does require them to treat all employees equally. That means the minute your company agrees to payroll advance for one employee, it must be willing to consider all future requests by any and all employees based on the same criteria.

Simply put, companies cannot offer payroll advances on a case-by-case basis. If they offer payroll advances to one, they must offer them to all. Establishing company policies first sets the criteria by which all payroll advance requests are either approved or denied.

3. Federal Lending Rules

This last consideration is one that encourages larger employers to avoid payroll advances altogether. Under federal law, an employer may be classified as a lender if their payroll advance practices meet a number of qualifications:

  • The employer charges a fee for payroll advances; and
  • Payroll advances are approved more than 25 times in a calendar year.

Being classified as a lender would make the employer legally responsible for complying with the Truth in Lending Act (TILA). Not only would that mean a slew of administrative responsibilities at the federal level, but it might also subject the employer to a variety of additional state regulations governing payday lending.

Payroll Advances Are Loans

The long and short of the issue is that payroll advances are essentially loans. As an employer, you are loaning your employee money against future wages. It is a loan even if you are not charging any sort of fee or interest. As such, you have to be very careful about how you structure such advances.

For a lot of companies, the administrative and legal implications of offering payroll advances are reason enough to avoid them. They are just not worth the trouble to deal with. That may not be good for employees who find themselves in the midst of a short-term cash crunch, but there is not much that can be done about it.