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Recovering Wage Overpayments: Navigating the Maze of Compliance

Employers should understand the differences among federal and state laws when attempting to deduct employee’s pay to recover wage overpayments, payroll professionals said May 10 at the American Payroll Association’s 2012 Congress in Kissimmee, Fla.

Even though the federal Fair Labor Standards Act does not require employers to receive written authorization from employees before making pay deductions to recover overpayments, state laws regarding such deductions usually require employers to acquire voluntary consent from employees and written authorization, said Barbara Youngman, CPP, payroll manager with Southwest Airlines.

In general, acquiring employees’ written authorization can help employers defend the legality of the deductions, Youngman said.

Generalized written authorization statements that employers can deduct wages to recover overpayments, without information regarding specific instances of wage overpayments, generally do not suffice, Youngman said. For instance, a general statement within an employee handbook that the employer can recover overpayments through deductions is insufficient authorization, she said.

Written authorization statements that define specific procedures for recovering a specific overpayment, including when the money needs to be repaid and the date it needs to be repaid, are permissible, Youngman said. Employers should not attempt to gain written authorization from an employee via email because an email signature generally is not considered a legally-binding electronic signature, she said.

If an employee refuses to sign an authorization statement that would allow an employer to recover overpaid wages, the employer should write on the statement that the employee refused to sign and should have a witness affirm the employee’s denial of signature so that it can be shown that the employee was notified of the situation, Youngman said.

Once authorized to deduct, employers then may need to comply with other laws that can mandate that certain deductions made cannot reduce an employee’s gross salary to below the federal or state minimum wage for that pay period, she said.

Variations Among State Laws

The differences among state laws regarding deductions to recover wage overpayments include when the deductions can take place and whether such deductions are permissible. The state where an employee principally works determines which state laws regarding wage overpayment recovery apply to that employee, Youngman said.

Illinois, for instance, mandates that employers cannot deduct wages to recover an overpayment beyond the first paycheck immediately following the overpayment, Youngman said.

Indiana employers can deduct overpayments after two weeks of notice to an employee, Youngman said. If an Indiana employer overpays by a factor of 10 due to a decimal misplacement, the employer can deduct the entire overpayment immediately, she said.

New York employers in most cases cannot deduct wages from employees to recover overpayments, Youngman said. However, New York employers can ask employees to repay the overpayments in a manner other than through deductions, she said. New York employers cannot take any retaliatory actions against employees that refuse to repay the overpayments, although employers can bring a civil suit in court to recover the overpayments, she said.

Tax Aspects of Overpayment Recovery

For a repayment made in the same year the overpayment was made, the employee should repay the net overpaid wages received instead of gross overpaid wages because the employer still can recover from federal agencies the federal income tax and employer and employee portions of Social Security and Medicare taxes that were withheld, said LaTisha O’Neal, CPP, payroll supervisor with Bank of Oklahoma.

For a repayment made in a year other than the year the overpayment was made, the employee should repay the gross overpaid wages, said O’Neal. While employers would not be able to recover federal income tax withheld on the overpayment because of constructive receipt rules, the employer can recover the employee and employer portions of Social Security and Medicare taxes paid because of the wage overpayment, she said.

Neither Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, nor Form W-2c, Corrected Wage and Tax Statement, would need to be filed if a repayment is made in the same quarter the overpayment occurred, O’Neal said.

If a repayment is made within the same year the overpayment occurred but in a different quarter, Form 941-X would need to be filed but Form W-2c would not, O’Neal said.

A repayment made in a calendar year following the one in which the overpayment occurred would need to be reconciled through filing Forms 941-X and W-2c, O’Neal said. Only Social Security and Medicare taxes could be recovered through the forms, she said.

A separate authorization letter is recommended to acquire an employee’s permission for the employer to recover the employee portion of Social Security and Medicare tax paid because of the overpayment, O’Neal said. If an employee does not give the employer authorization to recover the employee portion of Social Security and Medicare taxes, the employer still can use Forms 941-X and W-2c to recover the employer portion, she said.

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