Overpaying an employee is a mishap that flies under the radar but can lead to headaches. This particular payroll error can create a real financial burden for your business, and surprisingly, it may even damage the trust you’ve built with your team.
What you’ll learn
What you’ll learn
Key takeaways
- Identify the error, verify the amount, and document everything
- Notify the employee with a clear, written repayment plan
- Ensure all repayment methods comply with federal and state wage laws
- Fix internal payroll records and file corrected tax forms promptly
- Prevent future errors with clear payroll policies and routine audits
This guide will cover how to spot these issues, handle them legally, and protect your positive work culture. Let’s start by figuring out where things went wrong.
Start by identifying where the payroll error occurred
When it comes to common payroll errors, an overpayment is one of the trickiest. To find the source, you have to become a detective. Dig into your payroll process from top to bottom — checking everything from employee data and wage calculations to tax withholdings. Compare those records against the actual payroll output to see where the numbers don’t line up.
Once you find the discrepancy, you need to understand its nature. Was it a simple pay rate typo? Did a bonus get paid twice? Pinpoint when it occurred and list the employees it affected. A process breakdown will expose the root cause, whether it was human error, a software glitch, or something else entirely.
Confirm the overpayment and document the details
Finding the error is the first step. Now you have to prove it. For the sake of clear records and resolving any potential conflicts, you must verify the exact amount of the overpayment of salary and the specific period of time it covers. Documenting the overpayment of wages ensures transparency and compliance. Show your work in a text document or spreadsheet to prove exactly how you reached your conclusions.
Dealing with an overpaid employee is never a simple matter. It touches on legal compliance, accounting, and human resources. Because it’s so complex, you shouldn’t handle it solo. You need to get multiple departments involved to ensure your response is both comprehensive and legally sound.
Determine whether to force repayment or not
Now, it’s time to make a difficult decision: Do you make the employee repay the overpayment, or do you let them keep it? No repayment means losing money that, at the end of the day, belongs to you. On the other hand, repayment could impact the employees’ morale and potentially others. For what to keep in mind, we spoke with David Kindness, a CPA and frequent OnPay contributor, on some ways to approach this scenario.
Here are some factors to consider when making your choice:
- Overpayment amount: Is it substantial, or relatively small?
- Your financial position: Can you afford to let them keep the overpayment?
- The employee’s reputation: Are they well-liked and highly-valued? Have they been on your team for a long time, or are they new?
- Employee and team morale: Is the repayment worth a potential loss of morale?
- Fairness: Is allowing the overpayment fair to other employees?
— David Kindness, CPA
Whether you choose repayment or not, you’ll still need to have a sensitive conversation with the employee about what’s transpired. Also, the the table can help you evaluate the factors when making a decision.
| Factor | Pursue repayment | Let employee keep it | Key questions to ask |
| Overpayment amount | Large/substantial amounts | Small, negligible amounts | Is this amount material to your business? |
| Company financial position | Tight cash flow, every dollar matters | Strong financial position | Can you afford to absorb this loss? |
| Employee value | New or underperforming employee | Long-term, highly valued employee | What’s their contribution to the company? |
| Team morale impact | Error was employee’s fault | Company error, good team dynamics | Will this damage trust and morale? |
| Fairness consideration | Sets precedent for accountability | Maintains goodwill and loyalty | How will other employees perceive this? |
| Legal complexity | Straightforward case | Complex legal implications | Are there compliance risks? |
Include HR and legal teams in the verification process
Think of your HR and legal advisors as your overpayment response team. They’re likely your best defense against compliance headaches and damaged employee relationships. While you absolutely have the right to recover funds given to an overpaid employee, you have to follow the rules. Your legal team should know those federal and state laws inside and out, protecting you from missteps that could lead to legal challenges.
HR, on the other hand, manages the human side of the equation. Because they’ll have a handle on the people and culture piece, they’ll know how to have these tough conversations while ensuring fairness and maintaining trust. They also excel at developing the clear policies and processes necessary to prevent future errors.
Notify the employee and provide a written notice
Now for the most delicate step: talking to your employee. It’s critical to remember that this wasn’t their fault. They probably saw the extra money and thought it was a well-deserved bonus or raise, which is why you have to approach this conversation with sensitivity and total transparency.
Don’t just send an email. Schedule a private, one-on-one meeting. Acknowledge their contributions, then calmly explain the payroll error. This is where you provide a written notice that clearly documents everything. The notice should include:
- The total overpayment amount
- The specific pay dates involved
- At least one repayment option (and ideally multiple)
The goal is to agree on a repayment plan. This can be a simple voluntary agreement or a formal plan for deductions from a future paycheck. This conversation, backed by clear documentation, provides clarity for the employee and creates the paper trail you need for compliance.
Choose a repayment method that meets legal standards
Before you can start collecting funds, you need to be certain your repayment method is legal. This is non-negotiable.
While federal employment laws set a baseline for the U.S., state laws on wage deductions can vary dramatically. What’s legal in one state might be considered unlawful deductions in another. You absolutely must check your local laws or confirm with your legal team.
Most repayment plans use either a payroll deduction or a lump-sum payment. But there are rules. Any deduction from the overpayment payroll entry cannot push an employee’s pay below the federally mandated minimum wage for the hours they worked. While you can offer a lump-sum option, you can’t force an employee to accept it. They have to agree.
Adjust payroll records and correct tax documents
With a repayment plan settled, the conversation with your employee is done. Now it’s time to tackle the paperwork, making things right with your books and the IRS.
Correct the ledger
First, correct your payroll ledger. Accurate records are essential for your own accounting, year-end reporting, and (most importantly) avoiding future headaches.
The exact method for correcting the error depends on your system, but you’ll typically need to reverse the incorrect payment. In some payroll platforms, this means you have to remove a pay run entirely, voiding the original error before re-issuing the correct one.
Deal with taxes
Next up: tax forms. Unfortunately, you can’t skip this step. If the overpayment happened in a prior calendar year that you’ve already filed for, you’ll need to issue a Form W-2c, Corrected Wage and Tax Statement, to the employee. This is critical because it gives them the official document they need to file their own amended tax return.
You’ll also need to file Form 941-X, Adjusted Employer’s QUARTERLY Federal Tax Return or Claim for a Refund. This is the form you use to correct the Social Security and Medicare wages and taxes that you reported to the IRS for your business.
A word of caution: Don’t let this paperwork sit on your desk. The IRS has a specific time limit for filing corrections, so acting quickly is key to staying compliant and avoiding penalties.
This closes the loop on the administrative side. But what happens when the employee you need to work with has already left the company? That adds another layer of complexity.
Take additional steps if the employee has left the company
Sorting out an overpayment with a current team member is one thing, but what happens when the overpaid employee is no longer with the company? Suddenly, simple payroll deductions are off the table. Payroll overpayment recovery gets trickier. Thankfully, you’re not out of options.
Your first move, as always, should be professional and direct. Draft a formal letter that clearly explains the error and the exact amount owed, and include all documentation to back it up. Send the letter via certified mail so you have a record that it was received. In the letter, propose a clear and reasonable repayment option.
Remember, you can’t force them to pay in a lump sum. Your best bet is to be flexible. Offering a documented payment plan significantly improves your chances of getting the money back without a fight. Most people want to settle their debts; you just need to make it easy for them.
If they ignore your letters and refuse to cooperate, your last resort is legal action. Don’t take this step lightly. Lawsuits are expensive and time-consuming. The money owed might not even be worth the investment. Talk to your legal team to figure out the best course of action.
Navigating a recovery with a former employee requires patience and a clear process. Of course, an even better strategy is to make sure these overpayments don’t happen to begin with. Let’s talk prevention.
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“OnPay has made payroll completely painless. I was intimidated by hiring employees and setting up payroll, but they walked me through every step and handled all the tax filings for state and federal requirements. The platform is super easy to use, and their support team is wonderful — I can actually call and speak to a friendly person.”
— Kelly Langadinos, A Dog's Life Inc.
Implement prevention measures for future payroll accuracy
Preventing overpayments requires planning and diligence. You can stay proactive by adopting several best practices:
- Create and maintain clear, written payroll policies.
- Regularly train staff who handle payroll duties.
- Perform routine self-audits to catch errors like overpaid wages early.
- Automate as much of the process as possible with payroll software or an outsourced payroll provider.
Resolve payroll errors with confidence and compliance
Handling an overpaid employee is challenging, but a clear and respectful process protects your business, your team, and their future wages. With the right tools and policies, you can make these errors a thing of the past. See how OnPay can help your small business catch payroll errors early.
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Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.