Yes, Employers Can Usually Recover Employee Overpayment

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Employee overpayment is more common than you might think. It happens for a dozen reasons. Maybe a manager accidentally approved the same invoice or paycheck twice. Or perhaps a new accountant entered the wrong hourly rate into the payroll software.

The good news is that employers have the legal right to recover overpayment in full. In short, accidental overpayment does not justify an employee hanging on to the extra cash. Finders keepers isn’t a thing when it comes to your paycheck.

Here’s what to do if someone on your team has been overpaid.

An Employee Has Been Overpaid. What Next?

Keep calm and follow these steps. With patience, you can start your company on the path to recouping losses without sparking your employees’ frustration.

1. Find the Cause of the Employee Overpayment

Before you talk to the employee you overpaid, find out as much as you can about what happened and why. What is the root cause of the error? Finding out can help you prevent it from happening again.

Turn yourself into a detective, taking notes about each aspect of the overpayment. You’ll often find the answers you need as you examine every detail surrounding the overpayment.

Here are some of the details you’ll want to investigate:

  • Amounts: How much was overpaid? How much should have been paid?
  • Dates: Which pay period was affected? When was the overpayment made?
  • Employees affected: Did one employee mistakenly receive another employee’s paycheck?
  • Timekeeping: Did the employee use your company’s time clock software incorrectly or forget to clock out when they should have, resulting in unearned overtime pay? Do all the work hours line up with each employee’s schedule?
  • Payroll: Did a paycheck get approved twice, resulting in a double payment?
  • Keystroke errors: Check the data in every field of the employee’s pay stub. Does everything look correct, or is there an extra number or value somewhere?
  • Withholding: Some employees request different tax withholding on a bonus or award payment. Check to make sure the bonus was processed as requested.

Make sure you document everything you discover about what caused the overpayment. A full picture of the situation is necessary so that you can handle the situation correctly.

A clerical error on HR’s part or an oversight in the payroll process is different than an employee forgetting to clock out—especially if this person has forgotten before.

2. Provide the Employee Written Notice of the Overpayment

There’s no federal law stating the exact process you should take to recoup the overpayment. But several states, like Washington and Michigan, require that you inform employees about the overpayment in writing.

Even if it’s not legally required, documentation can help you keep a record of the overpayment and how it was handled.

You can use the information you collected in Step 1 to provide an objective account of what caused the overpayment.

Here’s what to include in the written notice:

  • Name of employee
  • Name of payroll department head
  • Date
  • Statement of overpayment, along with the reason why it happened, the pay period affected, and how such overpayment will be prevented in the future (if it was your fault)
  • Summary of the overpayment—lay out as much information as you can about how much was overpaid
  • An outline of the next steps
  • Your contact information so the employee can reach you to discuss the matter

We recommend giving employees time to review the overpayment notice before you establish a repayment plan. Above all, avoid sounding like the employee did something wrong—particularly if the mistake was on your end.

Some of the sample overpayment notices we’ve seen floating around the web use abrupt, demanding language that’s sure to put employees off.

You don’t want that. Put your kid gloves on and take the whole process one respectful step at a time.

A sincere apology for a mistake on your end goes a long way.

3. Agree to a Repayment Plan

The larger the sum of money, the more carefully you should tread as you put together a repayment plan.

No one wants to receive notice that they must pay back a huge sum of money they didn’t even know they owed. Some may not even realize that employers can legally recoup the money. If there’s a finders-keepers attitude on the employee’s end, things can really get tricky.

The most common way to set up repayment is to take deductions from the employee’s future paychecks until the full balance is recouped.

Make sure you check your state’s laws on this method, though. California and New York have strict rules for the types of wage deductions that can be made.

In New York, for example, you can only deduct wages from an employee’s paycheck if the overpayment was due to a clerical error on your part.

Another method is to request a payment plan from the employee. In this scenario, you treat the overpayment like an interest-free loan and the employee agrees to pay back X dollars over Y amount of time.

Spreading out the deductions or repayments over a long period of time can be a great way to soften the blow of big recoupments.

For instance, if an employee, Maria, received an overpayment of $1,500 two months ago, she might’ve kept it, thinking she got lucky. She’s overwhelmed when she finds out she has to repay this amount.

So instead of deducing $1,500 from her next paycheck, you agree to a $100 monthly repayment plan for 15 months.

Keep in mind that employees should still make minimum wage after a wage deduction. If your repayment plan causes their next several pay periods to dip below minimum wage, you could land in legal hot water.

The best thing to do is meet with the employee in person, hash out an agreement, sign it yourself, and ask your employee to sign it as well.

4. Update Payroll

As soon as you have a repayment plan in place, it’s time to update your payroll system to reflect the changes.

If the employee has agreed to a deduction on their next paycheck—or the next several paychecks—make sure you note the adjustment in your books.

If you’re using a payroll service, this is all pretty straightforward. Most payroll software services make it easy for you to adjust an employee’s payroll and attach documentation to the person’s profile.

This helps keep everything organized and cleaned up for tax time.

Employee Overpayment FAQs

How Long Do I Have to Correct Employee Overpayment?

It depends on the state you live in. New York allows just eight weeks for an employer to catch an overpayment and create a repayment plan. Tennessee gives employers 90 days, and Connecticut and Idaho give eight years.

What Causes Employee Overpayment?

  • Time clock errors: Employees forget to clock out or enter their time wrong, resulting in payment for time they were not working.
  • Double-approved paychecks: Sometimes, a paycheck can get approved twice, resulting in overpayment. This is usually a result of miscommunication between managers or other staff, especially if you’re changing payroll platforms, onboarding new managers, or doing anything outside of the normal routine.
  • Typos: All it takes is one extra 0 for you to pay an employee quite a bit more than they earned during a pay period. Typos happen, even with the best payroll software.
  • Withholding: If your payroll team takes incorrect deductions for things like bonuses, raises, or even regular pay, you might end up accidentally paying the employee money you actually need to send to the IRS.
  • Disorganized payroll: If you’re still doing payroll manually or with a cluster of Excel spreadsheets, the likelihood of messing up is high. You could accidentally pay an entry-level employee the salary a CEO gets, or vice versa.

Are Overpayment Repayments Taxable?

They are not taxable on the employee’s end because they do not count as compensation for that employee. If the overpayments are made and recouped in a single tax year, there’s most likely nothing to amend.

However, if overpayments are made in one tax year and recouped in another, it gets more complicated. Both employers and employees may need to file amendments to their tax returns. Talk to your tax professional to make sure you treat this situation correctly.

Can Employers Sue Employees for Overpayment?

Yes. Both federal and state laws assert an employer’s right to recoup overpayment. Of all the US states, California has the most protections for employees. A repayment plan is only allowed if the employee agrees to it. But if the employee does not agree, the employer can sue.

What Is An Overpayment Deduction?

An overpayment deduction is when an employer takes money out of an employee’s paycheck following an overpayment. Every state has different rules on whether deductions can be made, and for how long.

California has the strictest rules, with deductions only allowed with the employee’s explicit consent. Most other states allow automatic deductions or garnishments, but some require written notices first. Make sure you check your state and local laws for the most relevant rules to follow.

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