What to do if you overpaid an employee by mistake

In 2016, the Canadian government launched the Phoenix pay system to centralize pay for federal employees. What was meant to streamline payroll instead resulted in widespread chaos. The system overpaid thousands of employees by mistake. Many of them are still paying the government back.

This case shows the damage that payroll blunders can cause, hurting both employees and the organizations they work for.

In this article, we’ll look at what happens when employers overpay their workers in error. We’ll look at what laws say about recovering overpayments from employees – can deductions be made from their wages? We’ll also look at best practices in dealing with overpayments, including damage control and prevention.

Examples of overpayment

Payroll issues, though unfortunate, are not uncommon. Here are some examples:

• incorrect hours being processed for the employee
• timecard wasn’t correctly reviewed or authorized
• too many hours processed in a pay period
• wrong rate of pay was used
• payment to inactive employees
• vacation pay given, then employee was terminated or has resigned

We could classify these and other cases of over/underpayment into three categories:

• System or admin errors: data entry errors or glitches in the system could have caused these issues
• Misclassification of employees: hiring someone as a contractor, who’s then recorded as a full-time employee (and getting full pay and benefits) is a clear example of overpayment
• Failure to update payroll information: this happens when someone is on unpaid leave, or terminated, but continues to receive pay
• Unearned pay: employee has received pay in advance for work that has yet to be done

Here’s a 2018 report focusing on insights and lessons from overpayments in the Phoenix case. 

What happens when you accidentally overpay an employee?

Overpaying an employee makes a big impact across the organization, so take steps to fix it as soon as possible. Once an overpayment has been identified, the company should:

1. get the accounting/finance teams involved
2. work closely with payroll to assess impact on taxes, CPP, and EI
3. get in touch with the employee to recover excess payment
4. take further action if the employee does not cooperate

1. Get the accounting/finance teams involved

Overpayment of wages will have an impact on your payroll budget and, possibly, your financial reporting. Notify the accounting and finance teams as soon as possible to see what can be done to address the issue.

2. Work closely with payroll to assess impact on taxes, CPP, and EI

Check in with the payroll team to establish the root cause and the scope of the problem:

• Was it a system error? How many employees were affected?
• Is this a one-off issue, or has this been going on for a while?

If you’ve overpaid an employee by mistake, you would have also withheld higher amounts of tax, pension plan contributions, and EI payments. The next steps to take will depend on the reasons for the overpayment:

• Was it a clerical or system error?
• Or was it because the employee did not do their job?

There are other points to consider as well, so it is best to contact the Canada Revenue Agency. A CRA liaison officer can be available to assist you.

3. Get in touch with the employee to recover excess payment

It’s important to take a respectful tone when reaching out to the employee (or employees). Be honest and transparent while focusing on constructive ways forward to resolve the issue.

Agree on steps to recover the overpayment, whether that’s through a lump sum or several payments. Go over plans to deduct from future pay, but only if that’s allowed by law – more on this later.

Overpayments can be confusing and stressful for the employee. Show patience and empathy when addressing their concerns but stay focused on reaching a fair and timely resolution.

Document everything – you may need to refer back to this if you decide to take legal action.

4. Take further action if the employee does not cooperate

If you don’t hear back from the employee or if they refuse to cooperate, taking legal action is an option. You may need to issue a demand letter or take civil action.

This could be a long and complicated process, so weigh the costs vs. the benefits. Consult one of Canada’s best employment lawyers to help you arrive at a decision.

Can an employer take back money if they overpaid?

The easiest solution to recover funds would be to deduct that from their wages... or so it would seem. In some cases, wage deductions for anything other than taxes or pension payments are considered illegal.

Let's go over these employment standards in more detail:

Federal

Under the Canada Labour Code, federally regulated employers can make payroll deductions to recover overpayments.

Alberta

The province’s employment standards allow employers to deduct from an employee’s earnings:

• when the law requires it (e.g., taxes, CPP, RRSP, employment insurance)
• when overpayment was made due to payroll errors
• to recover vacation pay that was given in advance
• when a collective agreement authorizes it
• when the employee approves, in writing, to make the deductions

When recovering payment due to payroll errors:

• employers don’t need written approval from the employee
• employers will need to give written notice to the employee before deductions are made
• only overpayments made within the previous six months can be recovered by the employer

These last points are among the changes made to Alberta’s employment standards in 2020.

British Columbia

An employee can give written consent to the deduction for an overpayment. Should the employee not consent to a repayment arrangement, the employer cannot withhold wages.

Manitoba

If there’s a mistake in pay, the employer can fix it as soon as they or the employee notices it. They should agree together on how and when to fix it, either in one payment or in smaller amounts.

If the employer and employee can’t agree, the employer can still make deductions like they would if they had a court order under The Garnishment Act. Refer to Manitoba’s Quick Guide to Employment Standards for more details.

New Brunswick

Under NB’s rules of payment, employers should contact the Employment Standards Branch for deductions other than those allowed by law (e.g., pension).

Newfoundland and Labrador

Under paragraph 36.3 of the Labour Standards Act, overpayment can be deducted from wages.

Northwest Territories

Companies in NWT that overpaid an employee by mistake cannot deduct the overpayment from wages. This is considered unlawful.

Nova Scotia

Employers in Nova Scotia can recover overpayments from employees’ wages. These are considered lawful deductions under the Nova Scotia Labour Standards Code.

Nunavut

Overpayment recoveries through wage deductions are allowed if:

• the employee gives written authorization
• the authorization includes a specific amount
• the authorization is signed by the employee

These protections are in place to make sure the employee knows what they are signing.

Ontario

Under the Employment Standards Act (Payment of Wages), employers cannot deduct money from an employee’s wages for overpayment unless the employee gives written permission. This authorization must include a specific amount or formula for calculating the deductions.

Here’s a more detailed explanation on how employee deductions work in Ontario.

Prince Edward Island

Under PEI’s Employment Standards Act (section 5.5), an employer can make certain deductions from an employee’s pay if the employee gives written authorization.

Québec

Wage deductions can only be made under certain conditions such as:

• an Act
• a court order
• an order or decree
• collective agreement

The employer can deduct overpayment only if the employee gives written consent. It must state why the deductions are being made. This written consent can be taken back at any time.

Saskatchewan

Employers are not allowed to make deductions if they overpaid an employee by mistake. The only deductions that can be made are those required or allowed by law, such as income tax deductions or pension plan payments.

Yukon

The Employment Standards Act does not allow employers to make wage deductions unless the employee gives written authorization. Even then, deductions are only for:

• donations to a charity
• contributions to a pension plan
• income tax purposes
• payments to an insurer
• payments to meet credit obligations

By this definition, deductions to recover overpayment of wages are not allowed under law.

Best practices to prevent future payroll errors

Dealing with the outcome of overpaying an employee by mistake is costly, stressful, and time-consuming for both the employer and employee. The organization also has to deal with reputational damage, depending on the extent of the issue.

What can organizations do to prevent incidents of overpayment? Here are some best practices:

• Use automated payroll software with validation checks
• Set clear timelines and triggers for stopping or changing pay
• Ensure that HR and finance systems are synced and updated regularly

More details on each of these points:

Use automated payroll software with validation checks

A good payroll system will have validation rules to flag errors quickly. It’s worth investing in good HR software to spare your organization headaches from overpayment or underpayment issues.

Go over our list of the best Canadian HR software technology for your choice of payroll software.

Set clear timelines and triggers for stopping or changing pay

When these changes happen, HR and payroll should be informed right away:

• resignation or termination
• the start or end of a leave of absence
• change in job title/pay grade
• employee onboarding
• bonus or commission approval

To avoid overpayment, HR should work with managers to define who is responsible for reporting changes.

Acting quickly makes a huge difference. Delays, especially in offboarding, are one of the most common sources of payroll errors.

Ensure that HR and payroll are synced and updated regularly

This is a perfect example of “the left hand should know what the right hand is doing.” We’re not just talking about systems – we're referring to people, too!

Just as HRIS and payroll tools should sync and integrate seamlessly, HR and payroll teams should communicate well. Both teams should be updated on staff movements, departures, and promotions. Unless this happens, your organization will keep overpaying an employee by mistake.

The impact of overpaying an employee in error

The government’s Phoenix system serves as a cautionary tale on how damaging and costly payroll errors can be. Recovering overpayments isn’t straightforward either; some provinces have strict rules on what deductions can be made on wages.

The key lies in a few factors:

• a reliable payroll system
• efficient triggers and checks
• steady flow of communication between HR and payroll

Above all, stay updated on employment standards for the province or territory you operate in. Read and bookmark our employment law section for the latest in labour legislation.