How to Correct a Payroll Overpayment

Employees are regularly paid too much for a given pay period, often due to simple human error. But how do you deal with such payroll overpayments, and set things right again? 

You’ve come to the right place. Read on to get the answers you’re looking for. 

What Causes a Payroll Overpayment?

Everyone makes mistakes, including HR managers. Human Resources professionals are, like the rest of us, only human – even if some of them don’t like to admit it. 

Payroll overpayments are usually the result of minor mistakes. HR might deposit a bonus into the wrong employee’s bank account, or an account manager might accidentally mismatch paychecks to two different employees. 

Making an error and overpaying an employee is the easy part – remedying the situation is a bit more difficult. 

What Can I Do to Fix a Payroll Overpayment?

When a business overpays an employee, HR often chooses to make a matching deduction from the employee’s next paycheck. Though this is the easy way to address the error, it’s often not the best way to handle the situation. 

The optimal solution hinges on whether the overpayment was noticed before the funds were transferred to the employee, or after. 

Payroll Overpayment Solutions

Before Employees Receive Payment 

If the employee being overpaid does not receive payments via direct deposit, HR may be able to contact the employee and cancel the check before the funds are deposited or paid out and issue an accurate paycheck.

After Employees Receive Payment

Undo, Redo 

If the employee’s bank account has already been credited with the overpayment, the mistake can still be fixed, but the process is a bit more complicated. 

We highly recommend first asking the overpaid employee if it’s possible for them to return the entire paycheck so you can start over. You might be embarrassed about your HR mistake, but it’s worth asking and saving yourself a serious headache later. If the employee is willing to return the inaccurate paycheck, simply issue another one – with the right total this time. 

Deductions

Many HR managers will simply deduct the amount of the overpayment from the employee’s next paycheck, which often seems like the path of least resistance. But it’s crucial to move carefully through the correction process, checking and rechecking your calculations. 

Be sure to pay attention to how the overpayment affected the taxes paid by the employee, and the employer, and carefully make the appropriate alterations.  

A Common Mistake

When HR tries to solve an overpayment by starting a deduction plan for an employee’s subsequent paychecks, a common problem is that the employee ends up actually losing money because of the way the process is executed. 

For example, let’s say that your employee Jim receives his payment by direct deposit. Last week, Jim’s deposit included an extra $175, a bonus that was meant to be deposited into his colleague’s account instead. 

Jim, being a conscientious employee, explained the error to his HR manager, who proposed that Jim keep the $175, and the same amount would be deducted from his next paycheck. 

The issue here is when the deduction is made and how it affects taxes. If the usual 12% federal income tax is taken from Jim’s normal paycheck of $1,000, he receives $880. But if a 12% federal income tax is taken from his overpayment check of $1,175, then he’ll get $1,034. This is a difference of $154. 

Now let’s take a look at the numbers when HR resolves the mistake via a deduction. If HR deducts the $175 after taxes have been taken out – meaning a deduction of $175 from the $880 typical take-home pay – then Jim will receive $705. But if HR deducts the $175 before the 12% federal income tax is taken out, Jim gets $726 – that same difference of $154 from his normal pay, and the problem is resolved. 

Things to Keep in Mind

Employee Needs

As the HR manager, it’s your responsibility to contact an employee who receives an overpayment and resolve the issue. If the plan is to make a deduction, be respectful of the minimum pay total an employee needs until the overpayment is resolved. 

Federal and State Laws

The US Department of Labor’s position is that businesses are entitled to deduct payroll overpayments from an employee’s future paychecks as needed. But some states have additional labor laws in place that set restrictions on how businesses can recover overpayments. 

Be sure to check with your state and make sure your HR practices follow legal requirements.  

Generally, the best policy is to speak directly with the overpaid employee and agree on a resolution. 

How to Prevent a Payroll Overpayment

The best way to prevent payroll overpayments is by building a more accurate payroll processing system. It’s a good idea to review and update training procedures and consider adding regular refreshers. You could also set up safeguards, such as requiring multiple levels of approval before payments are issued, to ensure accurate compensation. 

Conclusion

Understanding payroll overpayments and how to deal with them is an essential aspect of HR. You should now be much better equipped to recognize and resolve such errors – though they are quite common and simply human. 

Even so, with a bit of hard work and determination, you might be able to avoid them entirely.