What Are Employee Overpayments?

Employee overpayments are defined as any amount on an employee’s paycheck that is more than the amount the employer expected.  There are many reasons that overpayments may occur, and many ways to correct them, but it is important to remember these two key points:

  • A payroll mistake has been made that, once resolved, needs to be researched for root cause and future prevention.
  • There is a human being on the receiving end of the overpayment who may or may not have had anything to do with the overpayment, and who is now potentially in debt to the employer instead of the other way around.  This is not a comfortable position for most employees.
A comic strip about overpayment
Dilbert Comic Strip on 3/16/04, Dilbert by Scott Adams

Common Employee Overpayment Types

Overpayment can happen in many ways, but here are four parts of the process that are particularly vulnerable to error.

  • Bonus or commission amounts are typically calculated by another team or teams and then provided to payroll just before it is time for processing.
  • Payroll can experience keying errors, typos, or mistaken identification numbers, especially if there are multiple manual processes used.
  • Reimbursements are monies being repaid to an employee for business expenses. They are typically provided by an external group, like the expense reimbursement vendor or Accounting Department, limiting payroll’s ability to validate the accuracy of the reimbursement amounts.
  • Year-end adjustments to capture taxable benefits or events or to reallocate earnings, deductions or taxes may cause an overpayment by way of under-withholding.  The reduction in tax results in an unexpected higher net check.

Tips to Prevent Overpaying Employees

As with any payroll process , double-checking or auditing is the key to preventing errors, as is using the proper information for the audit.  To prevent employee overpayments, you might include an audit that compares the current gross pay amounts for each employee, department, or division against the gross pay amounts in the prior pay cycle for the same employee, department, or division. An explanation for each variance, if any, should be included before moving forward in the process.

Another way to prevent overpayments is to ask lots and lots of questions.  If a list of bonus payments is emailed to you and one of the amounts is three times larger than the others, the correct course of action is to reply to the source for confirmation of the large amount or, better yet, the file total. This provides an additional layer of audit support for your payroll files.

What Should You Do if You Overpay an Employee?

In all overpayment situations, there are two processes to be completed:  The error must be corrected administratively, and communication must be sent to the employee who has been overpaid.

The US government does not regulate the collection of overpayments through payroll deductions.  Employers are entitled to collect any overpayment from an employee regardless of whether or not the employee has spent the money or not.

States view overpayments differently, so there are different rules depending on the state the employee is paid in.  Which administrative corrections need to be made are determined by the type of the overpayment, when the overpayment occurred, and where the employee is paid.

Identify the Type of Overpayment

Identifying what type of earnings or payment is involved with the overpayment is the first step towards correcting the error.

  • Bonus or commission overpayments: work with the team who provided the data to determine the amount of overpayment.
  • Payroll overpayments: communicate with the employee immediately and outline repayment schedules or options.
  • Reimbursements: work with the appropriate team or vendor who provided the data to determine the amount of overpayment.
  • Year-end overpayments: research and process necessary adjustments or amendments to correct over-reporting.

Determine the Timing of the Overpayment

Collecting an overpayment made in the same year is simple.  The employee is to pay back the net amount (the amount after withholdings) they were overpaid by. This repayment may be scheduled to come out as a lump sum from one paycheck or on a repayment plan as agreed to by both employer and employee.

Collecting an overpayment made in a previous year is more complex.  The employee pays back the gross amount (pay plus withholdings) they were overpaid by in order to reimburse the employer for the Social Security and Medicare taxes that were deposited for the employee in the prior year.  You also need to issue a W-2C (Corrected Form W-2) for the employee for that year.

Collecting an overpayment made to a former employee or an employee who left after the overpayment was made can be the most difficult.  If communications with and attempts to collect from the employee are unsuccessful, involve the accounting department and take advantage of their relationship with legal collection groups.

Pay Attention to Employee Location

While the federal government has no specific regulations for the collection of overpayments, many states have legislation in place to protect employees when overpayments happen.  In California, you are required to get the employee’s authorization before collecting the overpayment through payroll deductions.  In New York, you are not allowed to collect the overpayment through payroll deductions at all; only by personal check.

Communicate About the Error

Now let’s consider how to communicate with the employee who has been overpaid. Let’s assume that the employee still works in your organization.

It’s best to have an in-person conversation with the employee and show them the supporting documentation or numbers. If it must be written, apply the tips below and be as clear and concise as possible. If possible, have another person on your team review the communication for clarity and tone before it is sent.

Prepare the communication as if you were explaining the issue in an educational setting, without any emotional or personal remarks that might be mistaken for a lack of professionalism. Use simple terminology by avoiding acronyms or nicknames, such as FIT or SUI, that aren’t well-known or specific to your company.

The main parts of the communication are:

  • The explanation of what has occurred;
  • An apology for the error or inconvenience; and
  • The most important part, from an employee’s perspective: how repayment will impact future paychecks.

If the repayment will be deducted in one lump-sum repayment amount, use the payroll system to run a sample paycheck so you can include an estimated net pay result to the employee.  If the repayment will be deducted over a number of pay cycles, include a calendar with the exact dates and amounts to be deducted. If the employee has choices, outline them clearly, answer any questions, and honor their decision. If they do not have choices, explain why.

At the conclusion of the message, provide an acknowledgement statement for the employee that allows an email reply or can be signed in hard copy to serve as employee authorization.