Recovering overpayment from a payroll error

If a payroll error led to an overpayment to an employee, what are the best ways to recover the overpayment?

Recovering overpayment from a payroll error
Brian Johnston

Question: If a payroll error led to an overpayment to an employee, what are the best ways for the employer to recoup the amount overpaid?

Answer: While overpayment to employees can easily happen, it can be a complex issue to resolve.

Overpayment occurs most commonly where the employee is paid for work they did not perform or where the employee is mistakenly overpaid due to a clerical or administrative error. The methods available to an employer to recoup the overpayment depend, to an extent, on the underlying cause. It is also important to recognize that the amount of the repayment must be determined, as tax consequences mean the amount may vary depending on the timing of events.

Navigating overpayment recovery options
Consider an employee who requests and is approved for advance vacation pay before they have actually earned it. After receiving the advance pay, the employee resigns. The employer has now paid the employee with respect to work that they will not ultimately perform and is left to attempt to recover the balance of the overpayment.

To ease recovery, the employer would benefit from pre-emptively drafting and having the employee sign an agreement that the employer reserves the right to recover any unearned vacation pay upon termination. Where no agreement or policy is in place, the employer may attempt to negotiate for repayment or unilaterally deduct from monies otherwise payable and risk a complaint or lawsuit or sue (which is likely not productive).

Where there is a mistaken overpayment, an employer is sometimes entitled to recoup an overpayment by making deductions from future wages payable, but it must abide by the specific requirements applicable to each province and territory. Unilateral deduction of an employee’s wages is not permissible in most jurisdictions — most often, the employer must have the employee’s written consent. It is good practice to have an employee’s written permission prior to making deductions in any case.

It is always good practice to start by attempting to negotiate terms of repayment directly with the employee or former employee. A cordial letter that clearly sets out the details of the overpayment, the reasons it occurred and possible repayment schedule (especially if the amount is large) is a good place to begin. The fact that the employer has initially given the employee a chance to pay back the amount may help if the employee refuses and the employer later takes legal action.

The specific rules pertaining to deductions made from an employee’s wages for reason of overpayment differ among jurisdictions. Written authorization is required in all jurisdictions (either by statute or common law) except for Newfoundland and Labrador and Saskatchewan. In Saskatchewan, the employer may deduct an overpayment without written authorization, but only if the correction is made in the next pay period. In Newfoundland and Labrador, the employer is explicitly authorized to make deductions for the overpayment without written employee consent.

More specific rules pertaining to deduction vary from province to province. For example, Nova Scotia, Quebec, Ontario and Alberta all require written authorization specifying the amount of repayment in addition to consent. In Manitoba, the employer must obtain the employee’s consent and make the correction as soon as possible, or, alternatively, (if the employee does not agree to the deduction), it may be entitled to deduct an amount equal to what would be allowed if the employer had a garnishment order for the overpayment.

The bottom line is: Before attempting to recoup any overpayments through wage deductions, an employer must carefully review the relevant employment standards legislation and abide by the rules of that jurisdiction pertaining to overpayments.

If the employee refuses to provide written authorization for payroll deductions in a province where authorization is required, the employer’s only remedy would be to bring a claim against the employee.

If the employer decides to allow the overpayment and forgive the debt, the employer should add the amount to the employee’s income in the year that the debt was forgiven.

The amount the employer may recover
Where an employer is permitted under law or by authorization to deduct the overpayment from the employee’s wages, the amount of the repayment depends on the circumstances.

Where an employee repays the overpayment, the overpayment does not form part of the employee’s salary for the year — this means that if the error is noticed and the amount is repaid within the same tax year, the employee must only repay the net amount of the salary overpayment (gross pay less deductions for income tax, CPP and employment insurance), and the employer is able to reduce the deductions made on the employee’s subsequent paychecks to compensate. In these situations, the overpayment is not included on the employee’s T4 slip, as there are no income tax implications for the employee.

However, it becomes more complicated when the overpayment is not repaid until the following calendar year. In those cases, the employee must repay the gross amount of the overpayment to the employer, including the income tax, CPP contributions and EI premiums that were deducted, and they would then need to apply to the CRA for a refund of these amounts.

This complication may soon become an issue of the past. In January 2019, the Department of Finance Canada released draft legislative proposals to the Income Tax Act, Canada Pension Plan Act and Employment Insurance Act that would allow employers who have made overpayments to be directly reimbursed by the CRA for these salary deductions. This means that employees will only have to repay the net amount of the deduction regardless of the timing, and the employer can sort out the rest with the CRA. These draft proposals have not yet become law.

An employer may not adjust the T4, payroll records or total employment income by the amount of the repayment — it should always include the amount of the salary overpayment and any deductions made on the employee’s T4 slip. If the employee has repaid the overpayment, an employer may give the employee a letter confirming the year that the overpayment was made, the year the repayment was made and the amounts. With that letter, the employee may claim a deduction on their income tax for the year the amount was repaid — at least until such time as the proposed legislative changes may come into effect.

 


Brian Johnston, Q.C., is a partner with Stewart McKelvey in Halifax. He can be reached at (902) 420-3374 or [email protected]

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