Tax Impact of Overpayments Depends on When Repaid


Timing is important in determining the tax impact of wage overpayments, payroll practitioners said May 17 at the American Payroll Association’s 36th Congress at National Harbor, Md.

If the overpayment is repaid in the current tax year, the employee repays the net amount received, the employer adjusts the employee’s wages, and the payment is voided, said LaTisha O’Neal, CPP.

If the overpayment is repaid in a subsequent year, the employee repays the gross amount and the Federal Insurance Contributions Act taxes can be refunded but not the federal tax withheld, O’Neal said. The employee repays the gross amount because the employee most likely received a tax benefit on his or her federal tax return, she said. 

To receive a refund of FICA taxes, the employee must give consent for the employer to file a claim and must provide a written statement stating that the employee has not and will not claim a FICA tax refund, O’Neal said.

Voluntary Deductions 

The Labor Department treats overpayments the same as a wage advance or loan, said Barbara Youngman, CPP, senior payroll analyst for Toyota Motors North America.

This means that the employer can recoup an overpayment from an employee’s future wages, but can’t reduce a salaried employee’s pay, said Youngman, who is a former APA president and is on Bloomberg Tax’s Payroll Library Advisory Board.

Some states say the deduction from wages must be voluntary and expressly authorized by the employee in writing, Youngman said. A voluntary repayment is one that is made without fraud or duress, she said.

An authorized repayment is written, not a condition of employment, and gives the employee the ability to withdraw, she said.

North Carolina, for example, gives employees an opportunity to withdraw a written authorization. Maine doesn’t require written authorization and allows a maximum deduction of 10 percent of the employee’s net pay, Youngman said.

Employers can deduct from bonuses in those states where bonuses are included in wages, she said.

If the overpayment is more than $10,000, then the employer must charge interest, Youngman said.

Employers should follow a five-step process when collecting overpayments, Youngman said. They should start deducting after partnering with their human resources department, documenting a plan, contacting the employee, and collecting the authorization forms, she said.