Reviewing the most recent payroll only to discover an error can put a small business owner’s stomach in knots, but if this has happened to you, you have company! Approximately one in five employees experience payroll inconsistencies, and around 18% of business leaders report that payroll complexity is among their biggest challenges.
What you’ll learn
What you’ll learn
Updated: August 8, 2025
Key takeaways
- Payroll reversals must be initiated within five business days of the original payment’s settlement date under NACHA regulations, after which automatic recovery becomes impossible
- Unlike refunds or voids, reversals are all-or-nothing transactions that must recall the entire payment amount, not just the portion that was incorrect
- Written employee notification is legally required for all payroll reversals, even though direct deposit agreements already authorize such corrections
- Quality payroll software providers handle the technical submission process with banks, making reversals more manageable for small businesses than direct bank interaction
While minor issues can be fixed in the next pay cycle, some less common errors — such as a direct deposit to a terminated employee, a duplicate payment, or a decimal point in the wrong place — are naturally more challenging and panic-inducing. For these errors, you need a specific solution: a way to undo the transaction and pull the funds back. This more involved corrective action is called a payroll reversal.
It’s important to act within the business day window, communicating with the employee or former employee to avoid a negative impact on the business. This guide will explain what a payroll reversal is, how to reverse errors when they happen, and some rules to keep in mind.
What does payroll reversal mean?
A payroll reversal is the process of canceling and pulling back an entire payroll transaction after funds have been distributed into an employee’s account. The process represents an official request made through a financial institution. It’s an all-or-nothing action, recalling the entire payment.
So, when can payroll be reversed? Reversals are reserved for specific, critical errors, including:
- Duplicate payment
- Incorrect payment recipient
- Incorrect payment amount
- Payment date earlier or later than intended
A reversal is also a legal method for recovery if you uncover a major bank error.
Is a reversal the same as a refund or void?
While a reversal may seem similar to a refund or payment void, the terms aren’t interchangeable. The key differentiator is timing.
A reversal is a one-sided recovery of funds, undoing the original transaction. Meanwhile, a refund is a two-sided process, often returning “new money” to the payee, and it can occur at any time after the original transaction. And a void stops a payment before it occurs — this is different from cancelling and deleting payroll runs that haven’t been cashed or processed yet.
The reversal is its own unique beast, with specific legal and compliance considerations.
How long does a company have to fix a payroll mistake?
According to NACHA rules, a company has five business days from the payment’s original settlement date to reverse payroll. After that time frame, it’s generally impossible to automatically reverse a payroll error.
— Peggy James, CPA
Understanding the rules: Legal and compliance considerations
Payroll reversals are serious, governed actions you can’t perform arbitrarily. The National Automated Clearing House Association (NACHA) is the organization responsible for establishing the rules governing all direct deposits in the United States, and while it isn’t a federal agency it works closely with them. Its rules and standards protect everyone involved in a transaction — employers, employees, and financial institutions. Failing to comply with its regulations can result in penalties and legal consequences.
Key compliance requirements you must follow
While a payroll direct deposit can be reversed, the reversal must occur within five business days of the original payment’s settlement date. This urgency is to allow the employee’s financial institution to act before the employee spends the funds. If you miss the five-day window, you cannot use the reversal method.
In addition to timeliness, NACHA stipulates an “exact amount” rule. Partial reversals are prohibited. If your company overpaid an employee by $200 on a $1,000 paycheck, it must reverse the entire $1,000, not just the $200 overage.
Employer and employee rights in a payroll reversal
The law requires employers to notify employees in writing that a reversal is pending. Notification of the pending transaction ensures employees aren’t surprised by the withdrawal and understand why it’s happening. Every direct deposit agreement already requires an employee’s authorization for such corrections, but employers are still required to notify them.
While federal NACHA regulations set the baseline, you should also be familiar with the direct deposit laws by state. These rules often provide further protections for employees and govern how you can recover funds if a reversal fails.
Preparing for payroll reversal: First moves
It’s essential to have all the facts straight before filing a payroll reversal request. Taking a beat allows you to collect essential documents and reduce the risk of further mistakes.
First, gather all relevant documentation related to the error. These documents may include the original payroll report, relevant employee timesheets, and any specific error symbol or encumbrance error. Having these documents on hand speeds up the resolution process.
Next, double-check the mistake to confirm its exact nature and scope. Ask yourself:
- Was only one employee affected?
- Was it a simple data entry mistake or a larger system glitch?
Understanding the root cause can help prevent future issues and inform the development of effective prevention strategies.
Can a payroll direct deposit be reversed?
Yes, but the timing is critical. The reversal can only be done within five business days of the original payment date. And it’s only possible to reverse the entire amount of the payment, so you can’t reverse only a portion. If you overpay an employee, you’ll need to reverse the original transaction, then pay them the correct amount as soon as possible, usually with an off-cycle payroll.
— Peggy James, CPA
How to execute a payroll reversal: A step-by-step guide
With your documentation in hand and a clear understanding of the error, you’re ready to execute the reversal. A clear process, with the aid of modern technology, makes a payroll reversal straightforward.
Using payroll software for reversals
For most small businesses, a reversal doesn’t typically involve direct interaction with the bank; instead, it’s usually a process initiated through their payroll processing organization. A quality payroll software provider acts as an intermediary with financial institutions, handling the technical submission of reversal requests. At OnPay, our support team is ready to guide clients through the process.
The 4 steps of the reversal process
When you’re ready to begin the reversal process, follow these four steps:
- Initiate the reversal: Formally requesting a reversal through your payroll provider starts the clock on the process.
- Notify the employee: You must immediately notify the affected employee. Detail the error, the amount, and when they’ll be paid correctly.
- Create the reversing entry: To keep accurate records, you must create an accrued payroll reversing entry to cancel the erroneous transaction.
- Issue the correct payment: You’ll need to run an off-cycle manual payroll payment to pay the employee as soon as possible.
One of the benefits of direct deposit for employers is that it makes the reversal process easier, from your recovery of the money to your employee’s replacement paycheck.
The role of regular payroll audits
A regular payroll audit can help you prevent errors and mitigate the need for a payroll reversal. By taking proactive measures (like reviewing payroll registers before final pay period submissions), you can catch mistakes before they require administrative interference, saving time and stress.
Of course, even with the best process, overpayments can still happen. The next step is knowing how to recover those funds.
Recovering overpayments
Unfortunately, sometimes reversals get rejected or employers miss the five-day window. When that happens, how do you recover overpayments when a reversal isn’t possible?
Methods for recovery
When you no longer have an option to automatically pull back funds, you must seek the employee’s cooperation. In most cases, you’ll need the affected employee’s written permission to deduct the overpayment in installments from future paychecks. Any deduction must comply with specific state laws.
Handling overpayments to ex-employees
For overpayments to ex-employees or temporary staff sourced from an employment agency, a payroll reversal isn’t possible. Your only recourse is to contact the employee, explain the error, and request they return the funds. If they are uncooperative, you may need to take legal action to recover the funds.
“OnPay is a comprehensive and affordable payroll system. The menus are intuitive, and if there’s ever a need for clarification or support, their customer service reps are knowledgeable and helpful. Hold times are minimal, and it’s a great value.”
— Norman M. Golden, EA
Preventing future errors and maintaining accurate records
Ultimately, the best way to handle payroll reversals is to have systems in place that prevent mishaps from happening in the first place. Putting strong corporate policies together and leveraging technology are important steps in the process. Using a reliable payroll software can also go a long way to keep everything error-free before you ever hit submit.
OnPay gives small business owners peace of mind. With the software’s automated tax and payroll calculations combined with multiple opportunities for review, it reduces risks even further. Are you ready to run payroll with confidence? Learn more about how OnPay can help your business.
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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.