With 63% of Americans living paycheck-to-paycheck, a single unexpected expense can send the financial plan of over half of American families into a tailspin. Financial emergencies can be extremely difficult for those who have limited options. They often turn to high-interest loans and credit cards to get by until payday. An answer for businesses? Payroll advances.
With payroll advances, payday can come early. When employers offer this option, they give employees a safety net they can rely on when times are unexpectedly tough. Payroll advances help your employees and are a great way to become a desirable employer to potential new employees.
In this article, we’re digging into all the details: What advances are, how they work, and how you can effectively implement them into your small business.
What is a payroll advance?
A payroll advance is a financial agreement when an employer gives employees early access to funds before a set pay period. The employee is then expected to repay the advance with future wages earned. Every advance has set terms and conditions.
It may not be common to see them, but they can be helpful in times of financial stress.
How does a payroll advance work?
All payroll advance requests should be submitted in writing to make sure there is a record of each step of the process. Use your employee handbook to outline how team members can submit their request.
Once you’ve received a request, you need to decide if you can fulfill the request. Inform your employees of your decision as quickly as possible so they can make alternate arrangements if needed.
A written agreement should be a part of any payroll advance. The agreement should include:
- The employee’s name and contact information
- The date of the advance and the amount
- The date of the first deduction and the frequency of deductions
- The amount of the deduction
- The company’s right to collect any remaining balance if the employee is no longer employed
Make sure both the employer and employee sign the agreement.
Advances should be paid out separately from your regular payroll. This should be easy to do with payroll software, but you can manually cut a check to cover the costs.
Finally, deduct the amount from the employee’s wages according to the written agreement.
Are payroll advances legal?
Federal laws prohibit paycheck deductions that reduce an employee’s pay below minimum wage. But payroll advances are the exception to this rule. If an employee owes your business money because of an advance, you can withhold money to repay it.
Some states don’t allow this exception, so be sure to check with your state beforehand.
Businesses aren’t allowed to profit from payroll advances. You can charge an administrative fee to cover paperwork, bank charges, or recordkeeping changes, but you can’t make money off them. If you choose to charge an admin fee, keep it low.
Are payroll advances taxable?
Payroll advances are taxable as a part of an employee’s wages. But you won’t actually tax it. Instead of taxing the advance, deduct taxes on the total amount of their future paychecks before deducing the advance repayment amount.
This is where it gets a little complicated, so having payroll software like Homebase that does the heavy lifting for you is essential. By classifying the advance payment as something other than a regular payroll payment, you can automatically calculate the correct tax rates for your employees.
How to avoid problems with payroll advances
It’s important to have a payroll policy that outlines how payroll advances will work in your business. This will give you and your employees clarity around the process and make it easier for everyone involved.
Your business should have policies addressing the following issues to avoid problems.
1. Define how the process will work at your business
We covered how payroll advances commonly work above, but you’ll need to spend time thinking about how they’ll work in your business. How will employees request them? How will you approve them? How will the procedure of signing the paperwork flow? These are questions you should have answers to before you start your program.
2. Outline who is eligible
Do you require specific criteria to be met for an employee to be eligible? This is a personal decision, but if you plan to have eligibility criteria, you need to clearly outline that for all employees. You may require employees to have worked a set period of time before they can request one. Or, you could only offer payroll advances to full-time employees. Whatever your criteria, make sure it’s clear to all your employees.
3. Set advance maximums
Hey, you’re running a business. It isn’t reasonable for you to loan out excessive amounts of money. Because of this, it’s important to set maximums for your advances. Set a maximum on the dollar amount a single employee can receive. A maximum ensures you’re only loaning what you can afford to cover and gives you the best chance of recovering your money.
4. Set advance frequency
Your policy should outline how often employees can request advances. Most businesses limit employees to a payroll advance once every six months to help avoid confusion and avoid any potential legal issues. You should also state that employees can’t take out a second advance before paying off their first. Both of these policies will help to make sure you don’t run into any cash flow issues.
5. Get everything in writing
You should include all aspects of your policy in your written policies. Beyond that, everything surrounding a payroll advance should be recorded in writing—the payroll advance agreement, advance requests, and all communications in between should be in writing. Remember to have the agreement signed by the employer and employee and put a copy in the employee’s file.
6. Set up a repayment plan
Setting up a repayment plan makes sure that employees pay back their advances in a timely manner that also complies with state and federal laws. Repayment plans may vary slightly depending on the employee and the advance amount, but having set repayment terms will help avoid confusion. Your repayment plan should include when repayment deductions begin and end, the amount deducted, and any associated administrative fees.
7. Use a payroll software
Managing the additional admin required of payroll advances may make some small business owners decide against offering them. With the right payroll software in your corner, payroll advances can’t be more automated, less overwhelming. Payroll software can save you time and money while keeping your payroll accurate, even with taxes, deductions, and other factors.
8. No matter what, stick to your policy
You’ve spent all this time creating a payroll advance policy that covers all the bases—now’s the time to stick to it. Your policy is there to protect you, so make sure you’re using it for every payroll advance request.
On-demand pay as an alternative to paycheck advances
Payroll advances aren’t the only way to get money into your employees’ hands when needed. On-demand pay is another great option for employees looking for an advance on their pay.
On-demand pay lets employees access the wages they’ve already earned instead of waiting for their scheduled paycheck. For example, if your employees get paid on the 28th of every month, they can access their pay on the 15th for all the hours they worked from the start of the pay period until the 15th.
This is a less risky way to advance payroll because employees access the wages they’ve already earned just a little earlier than originally planned. Offering on-demand pay is also a great way to improve your pay experience and increase employee happiness.
Payroll advance FAQs
How can payroll software help you manage payroll advances?
Payroll software can help you manage payroll advances by processing the payroll advances as separate payroll payments. The best payroll software can put payments under different categories. Being able to categorize payments will let you correctly calculate taxes on payroll deductions with the click of just a few buttons. Without payroll software, you’ll need to calculate the taxes independently and arrange a separate check or e-transfer to the employee.