By Stefan Schumacher, editor of The Payroll Blog
There may come a time when an employee asks for an advance on his or her salary. Many people run into sticky situations from time to time (the car is totaled, the roof is leaking, etc.), where they need more money in the immediate than expected.
A small firm may have the flexibility, in these cases, to offer an employee an advance. This is not only a nice gesture, it’s also something that needs to be accounted for on the payroll. Any salary advance or overpayment needs to be included in the employee’s income for the payroll period that the money was received. Likewise, the employee is subject to federal income tax withholding and Social Security, Medicare and Federal Unemployment Tax Act (FUTA) taxes.
Like many aspects of payroll, advances, as well as overpayments, can become complicated. The employee typically has to pay back the advance, and if they do so in the same year it was received, then that repayment amount is not included in the employee’s income when completing the W-2 form. If the repayment takes place the following year, it cannot ever be excluded from the employee’s income.
With regard to Social Security and Medicare taxes, if the employee makes the repayment after the employer has filed Form 941 for the quarter that the overpayment was made, the employee receives a refund from the employer for any excess Social Security and Medicare taxes. This happens once the employer has filed a corrected Form 941-X to claim a refund.
For recordkeeping purposes, a receipt noting the date and amount of the employee’s repayment must be retained. The employee must provide a written statement declaring that he will not seek a refund. This must occur before the employer can claim its own credit or refund with regard to overpaid Social Security and Medicare taxes. When the repayment takes place in a year different from when the advance or overpayment was made, repayment does not decrease the employee’s Social Security of Medicare wages for the year of repayment. If the repayment results in Social Security or Medicare taxes on the employee’s part, Form W-2c will need to be filed by the employee.