In training sessions, this question often arises: 'Is there any problem with taking source deductions when earnings are banked, rather than when they are paid?'
By Alan McEwen
Banked overtime is a common payroll practice.
When overtime is banked, the issues that arise usually deal with whether dollars or time are banked, how long overtime may be kept in the bank and the rate at which banked overtime must be paid.
However, I have been asked to comment on the following practice, at several of the training sessions I have recently given.
In essence, this practice involves banking the gross amount of overtime earned. When it is subsequently paid out, no source deductions are taken. This is because source deductions were taken, when banked, on the total of the otherwise gross pay and the gross banked overtime. The question I have been asked is: “Is there any problem with taking source deductions when earnings are banked, rather than when they are paid?”
All source deductions are taken on a “cash” basis, meaning source deductions are taken on payments to employees. Source deductions must be taken on a cash basis, whether for income tax, Canada Pension Plan (CPP), EI or any of the provincial equivalents.
Similarly, employers are required to report T4s on a cash basis. If banked overtime, earned in 2012, was subsequently paid out in 2013, without further source deductions, I am pretty sure the employer would have reported this banked overtime on a T4 for 2012. Otherwise, how could the pensionable and insurable earnings for 2012 match the source deductions taken in that year?
The real question this practice raises is the timing of the “payment.” Is this banked overtime “paid” at the time source deductions are taken or is it only “paid” when overtime dollars are released from the bank.
For me, the answer has to be in how the employer accounts for the dollars concerned.
Assume the following treatment:
•overtime earned is shown on the pay stub as part of that pay period’s gross pay
•source deductions are taken on this gross amount
•banked overtime is deducted from the net pay remaining after source deductions.
Such overtime has effectively been paid to employees when included in gross pay. Any amounts banked, in the above treatment, are taken from net pay, not gross pay. So long as banking is permitted at all, I don’t see any reason why the gross amount of overtime can’t be deducted from net pay. In other words, in the above there are two separate transactions. First, the overtime was included in gross pay. And, second, the amount of this payment was deducted from the net pay otherwise owing.
What’s described above, of course, contrasts with normal practices for banked overtime, where banked amounts are not included in gross pay and source deductions are only taken when banked amounts are actually paid out.
While I don’t see any problems with either practice, both employers and employees should see the clear differences in how these practices affect both T4 and Record of Employment amounts.
When banked overtime is treated as part of gross pay when earned, the related taxable income is included in the tax year when earned, rather than when the bank is paid out. Similarly, in this scenario, the banked overtime is allocated for ROE purposes to the pay period the overtime was worked, rather than the pay period when banked dollars are released. Effectively, both T4 and ROE reporting is no different than if the overtime had been paid out when earned, without banking.
This will produce both “winners” and “losers.” “Winners” will be employees whose T4 incomes were lower in the tax year overtime was worked and higher in the year banked dollars were paid out. They benefit because the treatment described in this article effectively shifts taxable income from a high-income year to a lower-income year. As such, they probably would pay less in overall income tax.
Similarly, there might be “winners” and “losers” when ROE insurable earnings are shifted backward from pay periods overtime dollars were released out of the bank to pay periods when the related overtime was worked. For example, if this practice were followed, and the pay periods when overtime was worked fell before the 26 weeks used to calculate a claimant’s weekly benefit rate, that claimant will be a “loser” from this practice, since it might result in a lower weekly benefit rate.
Alan McEwen is a payroll consultant and freelance writer with over 20 years' experience in all aspects of the industry. He can be reached at email@example.com, (905) 401-4052 or visit www.alanrmcewen.com for more information.