Regardless of the reason for overpaying an employee, payroll departments must follow the rules for handling, recovering overpayments
Mistakes happen. No matter how careful payroll professionals are, sometimes they inadvertently pay employees more than they should. Through a data entry mistake, a company may accidently pay an employee $3,500 instead of $350. Payroll may erroneously pay an employee a premium for working on a statutory holiday when the employee was not eligible for it.
Not all overpayments, though, are the result of administrative errors. Sometimes, they stem from employers paying employees in advance for duties they end up not doing. This could happen if an employee takes a paid vacation and the employee later quits before earning the vacation.
Whether salary overpayments result from errors or employees not performing duties, payroll departments have to ensure they follow Canada Revenue Agency (CRA)/Revenu Québec rules and employment standards requirements for handling and recovering them.
The federal Income Tax Act does not address salary overpayments, but the CRA has administrative policies that cover overpayments resulting from clerical errors and employees not carrying out their duties. The way payroll has to handle the overpayment will depend on which category it fits in and when and whether the employee repays the amount.
The CRA does not consider overpayments resulting from administrative errors to be income for an employee if the employee repays the excess amount. If payroll discovers the error in the same year it made the payment, the CRA advises employers to ask the employee to repay the net amount (the salary or the wages minus the source deductions) of the overpayment. The employer may reduce its next payroll remittance to the agency by the amount of source deductions previously remitted by mistake if there is still enough time in the year to do so.
Once the employee repays the overpayment, payroll must remove it from the employee’s records and make sure it does not appear on the employee’s T4.
If payroll does not realize the error until the next year or later, the CRA requires employers to request that the employee repay the gross amount of the overpayment instead of the net. Once the employee repays it, payroll must amend the T4 for the year it reported the mistake to change amounts reported in boxes 14 (employment income), 24 (EI insurable earnings) and 26 (CPP/QPP pensionable earnings).
When the error is discovered in a later year, it is too late to reduce payroll remittances to make up for the source deductions taken; however, employers may submit a PD24 form, Application for a Refund of Overdeducted CPP Contributions or EI Premiums, to the CRA to request a refund of their share of the CPP contributions and/or EI premiums. Employers may request a refund of CPP contributions up to four years after the end of the year to which the overpayment applies. For EI premiums, the timeframe is three years.
Although the CRA does not consider overpayments made by mistake to be salary, this only applies when the employee repays the amount. If an employee refuses to repay the overpayment, payroll must include it in the employee’s income in the year it mistakenly made the overpayment.
If an employee promises to repay it, but fails to do so, the CRA will also consider the overpayment to be salary. Payroll must include the overpayment in the employee’s income in the year the employee agreed to repay it.
If an employer does not require an employee to refund an overpayment, the overpayment becomes employment income and payroll must report it on the employee’s T4 in the year the employer opts to forgive repayment.
The CRA also says it will consider an overpayment to be salary or wages if "there was knowledge or collusion" and the employee does not repay the amount. In this case, the CRA will consider the overpayment to be income for the employee in the year the employer made the payment.
Quebec differences
If employees in Quebec repay salary or wages paid in error, Revenu Québec does not consider the overpayment to be income. If employees repay it in the year they received it or before the employer files its RL-1 slips for that year, the employer should subtract the gross amount repaid from the employee’s earnings and only report the employee’s actual employment earnings in box A (employment income).
If the overpayment was also subject to QPP and QPIP deductions, the employer must enter in boxes G (QPP pensionable salary or wages) and I (QPIP eligible salary or wages) the employment earnings without including the amount repaid. If the employer has already filed its RL-1s, it must file an amended RL-1 for the employee for that year showing the employment income minus the gross repayment amount in box A.
If the overpayment is not the result of an error, but stems from the employee not performing duties, the employer must decide if the employee should repay some or all of the amount. If the employer opts for repayment, the employee must repay the gross amount of it. The CRA considers the payment to be a repayment of salary or wages.
Do not make any changes to the T4 on which the employer reported the payment or to the employee’s payroll records to reduce employment earnings or source deductions. The employer is not entitled to a refund of CPP contributions or EI premiums.
Once the employee repays the overpayment, the CRA advises that employers provide the employee with a letter that sets out the tax year the payment was included in the employee’s income, as well as the date, reason and the amount repaid in the year.
Employees can claim a deduction on their personal income tax return for the year of repayment if they include the letter with the tax return.
The employer should give the letter to the employee in the year of repayment. If the employee repays it over more than one year, employers have to provide a letter for each year.
For Revenu Québec, if the employee repays the overpayment in the year the employer paid it, the employer must subtract the gross amount repaid from the employee’s remuneration for the year and enter the difference in box A on the RL-1.
If the repayment relates to an overpayment made in a previous year, payroll must enter "A-3" in one of the blank boxes in the centre of the RL-1, followed by the repayment amount.
If an employer allows an employee to repay an overpayment in instalments rather than in a lump sum, the CRA may require the employer to assess a taxable benefit for an interest-free or low-interest loan.
When asking or requiring an employee to repay an overpayment, payroll departments have to make sure they comply with employment standards rules. The rules can vary, depending on the jurisdiction.
Provincial differences
In Nova Scotia and under the Canada Labour Code, for example, employers are allowed to make deductions from employees’ wages to recover pay advances and overpayments without needing the employees’ permission.
Manitoba allows for deductions to correct payroll errors, but the Employment Standards Board requires employers to make the deduction as soon as possible: "Failing to deal with the error immediately could be considered agreeing to a new wage."
It notes that employees and employers should agree on how and when the employer will make the correction. If they cannot agree, Employment Standards advises employers to deduct amounts equal to what they would be allowed to take if they had a garnishment for the employee under the Garnishment Act. In that case, employers can deduct up to 30 per cent of an employee’s net wages, with the employee still receiving a minimum of $250 per month if the employee has no dependants and $350 per month if there are dependants.
In Saskatchewan, Employment Standards allows employers to recover salary overpayments as long as the overpayment was the result of a clerical error and the employer catches and deals with it with quickly, making the deductions in the next pay period. Payroll should include the deduction on the employee’s pay statement.
If payroll does not catch an error right away, Employment Standards may not allow for deductions. On its website, Employment Standards states that, "If significant overpayments occur, the employer must either negotiate a repayment schedule acceptable to the employee; or in the case of disagreement, consider recovery through the courts."
British Columbia is among the provinces that require an employee’s written consent before an employer can recover overpayments or salary advances. "Should the employee not voluntarily consent to a repayment arrangement, the employer can’t use a withholding of all or a portion of wages as a remedy," says the Employment Standards Board’s Interpretation Guidelines Manual.
In Ontario, although the Employment Standards Act, 2000 only allows employers to make deductions without an employee’s permission under specified circumstances (such as for statutory deductions and under court orders), the Employment Standards Board’s Policy and Interpretation Manual states that employers may deduct wages paid in error from employees.
The reasoning is that, "(W)hen
an employee is overpaid, he or she was never entitled to the amount that the employer seeks to deduct, so it cannot be regarded as wages payable in the first place," the manual states. The Board allows employers to recover overpayments from regular wages, vacation pay and termination pay.
For information on each jurisdiction, contact the applicable employment standards board.
Whether or not an employee’s written permission is required, for good business practices payroll departments may want to obtain it and keep it in their records.
