What is a payroll advance?

What is a payroll advance? Definition and meaning

A payroll advance is a financial arrangement through which an employee receives money earlier than their scheduled payday from their employer. The money is provided in the form of a short-term loan that is to be paid back to the employer with future earned wages. Agreements vary, but terms should be clear to both the employer and employee.

Are payroll advances taxable?

Yes, payroll advances are subject to taxes. However, as an employer you won’t tax the advance when you pay it out. Instead, you’ll deduct the taxes on the total amount of an employee’s future paycheck. This will allow the employee’s wages to be taxed as normal.

Let’s say, Mary, one of your employees earns taxable wages of $2,000 on a biweekly basis. She takes out a salary advance of $200. When you deduct the repayment from her next paycheck, you’ll withhold federal income tax, Social Security tax, Medicare tax, and any state and local taxes from the $2,000. Then, you’ll deduct the $200 salary advance.

How do I record a payroll advance?

When you process a payroll advance to an employee, you must add it to your company’s financial records. Since a payment advance is technically a short-term loan, you can record it as a current asset on your balance sheet.

Depending on how often you distribute payroll advances, you may want to create separate categories for them titled employee advances or employee loans. You can also add employee advances to categories like other assets or other receivables. Fortunately, a payroll software can help you record payroll advances and alleviate the additional administrative burden they may bring.

What’s some best practices to provide a payroll advance?

If you decide to offer payroll advances to your employees, keep the following best practices in mind.

• Design a process: In most cases, the process for payroll advances will include a request by an employee through a form and a signed agreement that outlines the repayment plan and ensures everyone is on the same page.
• Determine eligibility: Clarify which employees may take out payroll advances. Maybe these loans are only an option to full-time employees or those who have been with your company for a set period of time.
• Implement caps and limits: Figure out maximum amounts for payroll advances. With a cap, your employees will be more likely to pay you back and become more financially responsible. You should also limit how many advances employees can take out each year.
• Provide financial education: Educate your employees on what payroll advances are, how they work, and when they should be used. It’s also a good idea to share other financial tips to help them budget and avoid excessive debt.