Payroll is a crucial task. If you have employees, they must be paid. Accidentally overpaying an employee is a common payroll error — and one of the most awkward. However, if you’re a small business owner, correcting an overpayment may be crucial to maintaining profitability.

The Big Picture

• Overpayment happens. The best way to approach this situation is to follow an unbiased protocol.
• Simplified payroll and time clock procedures are the best safeguard against overpaid wages.
• Requesting repayment can cause legal problems (and negatively impact your reputation).

What is a payroll overpayment?

Simply put, an overpayment is a type of payroll error. Payroll overpayments occur when someone’s paycheck has more money than they actually earned. These types of errors are surprisingly common, and are usually a result of human error or incorrect calculations.

Here’s a typical overpayment scenario: John is supposed to receive $20 per hour for a 40-hour workweek, totaling $800. However, a data entry errors accidentally lists John’s hourly rate as $25. John receives a paycheck for $1,000, or $200 than he actually earned. In this case, John has received an overpayment.

As a small business owner, what would you do in this scenario? Unless John comes forward and volunteers to give the money back, you’ve got a very awkward situation on your hands. And, while it’s legal for you to attempt overpayment collection, there is the potential for legal fallout (not to mention bad PR).

We’ve got some advice on the steps you need to take to correct payroll overpayment.

4 Common Causes of Payroll Overpayment

A not-so-fun fact: overpayments are one of the most common payroll errors. For context, the average company makes 15 payroll corrections per period. Here’s what to look for to prevent an overpayment from happening in the first place.

1. Convoluted Pay Scales

Complex pay structures make it more challenging to accurately calculate an employee's pay.

• Tiered systems: Employees are paid differently based on their experience, role, or performance level.
• Fluctuating rates: Pay rates change depending on the time of day, week, or season.
• Overtime and double-time: Additional pay rates for working beyond regular hours or during specific periods.
• Bonuses and commissions: Performance-based incentives that vary from employee to employee and pay period to pay period.
• Differential pay: Additional pay for employees working in specific locations or conditions, such as hazardous environments or remote locations.
• Shift premiums: Extra pay for working unpopular or inconvenient shifts, such as night shifts or weekends.
• Split payrolls: A combination of hourly and salaried pay structures for workers who perform different roles or tasks.

2. Forgetting to Clock Out

If an employee forgets to clock out at the end of their shift, the clock will keep running. If no one catches the missed punch, the employee will get paid for these hours, even though they weren’t working. Even worse, they might accumulate overtime pay for hours they never worked!

One way to avoid this is by choosing a web-based time clock with safeguards against missed punches. For example, OnTheClock can send reminders to employees when it’s time to punch out, as well as alerts for when overtime is about to begin. A good time clock will also allow you to easily correct errors as soon as you notice they’ve occurred.

3. Human Error

Mistakes happen! Several factors can contribute to human error in the payroll process, leading to overpaid employees. Some examples include:

• Data entry errors. Incorrect input of hours worked, pay rates, or deductions can result in inaccurate calculations.
• Misplaced decimal points. A tiny mistake, such as putting the decimal point in the wrong place, can significantly impact an employee's pay.
• Manual calculations. Errors can occur when manually calculating pay, especially if complex pay structures are involved.
• Misinterpretation of policies. Misunderstanding company policies or pay scales can lead to incorrect payroll calculations.
• Failure to update records. Not updating employee information, such as changes in pay rates, promotions, or deductions, can cause overpayments.

4. Miscommunication

A lack of clear communication between departments can result in inaccurate payroll calculations. This can happen when there is no established system for sharing vital information, such as approved overtime hours or changes in employee schedules. Some common scenarios where miscommunication can lead to an employee overpayment include:

• Shift changes: An employee switches shifts with a coworker, but the change is not communicated to the payroll department, causing a payroll mistake.
• Employee status updates: Changes in an employee's status, such as promotions, demotions, or transfers, are not properly communicated, leading to incorrect pay rates being applied.
• Absences and leaves: Payroll is not informed of an employee's absence or leave, causing the employee to be paid for hours they did not work.

How To Correct a Payroll Overpayment

So, you accidentally overpaid an employee. They’ve cashed their paycheck, and the only way to recover your lost funds is to ask. What’s next?

The first thing you should do is ask yourself: is it worth it? Chances are, if you’re reading this, you have a good reason for wanting to recover the money. And if the overpayment is significant, you’ll definitely need to act fast.

But, before you do, put yourself in the payee’s shoes. Even though the overpayment is the result of an error, they may feel as though they’re being asked to pay their employer. And if the error isn’t their fault, they may even be angry about it.

So, before requesting repayment, consider whether the amount is going to have a significant impact on your profits. A disgruntled former employee can damage your business’s reputation, which may cost you much more in the long run.

If you decide that recollection is very important, know that, under federal law, you are legally entitled to recollect payroll overpayments. However, you still need to act carefully. Each state has a regulated protocol for recollecting overpayments, which you’ll need to follow to avoid a costly legal battle.

Step 1: Gather Data

Before taking any action to correct overpaid wages, you’ll need to get your facts straight. It’s important to be able to actually prove that overpayment occurred.

• Review payroll records. Go through your payroll records for the affected pay period(s) to identify any errors or inconsistencies. This may include reviewing timesheets, pay rates, deductions, and other relevant data.
• Identify the cause. Once you've spotted the error, determine the root cause of the overpayment. Was it due to a data entry mistake, miscommunication, or another issue? Understanding the cause will help you prevent similar errors in the future.
• Calculate the overpayment amount. Determine the exact amount of the overpayment by comparing the employee's correct pay with the amount they received. Make sure to account for any applicable taxes and deductions.
• Document your findings. Keep detailed records of your assessment, including the cause of the overpayment, the affected pay period(s), and the overpayment amount. This documentation will be useful when notifying the employee and making any necessary adjustments to your payroll system.

Step 2: Check State Laws and Company Policies

Once you’ve documented the overpayment, you’ll need to make a plan for recollecting. That requires following both company policies and state overpayment laws.

For employers in the United States, the Department of Labor allows for you to recoup wage overpayments from employees, even if doing so brings their average payrate below minimum wage for their next paycheck. Additionally, many states regulate how overpayment may be deducted from a future paycheck.

If available, your human resources department or legal team can be great resources for guidance. Your company handbook may also outline a policy for correcting payroll errors. You can also do you own research on your state laws to make sure you’re compliant

Step 3: Notify the Employee

When addressing the overpayment of wages, it’s best practice to notify the employee in writing. While having a heart-to-heart discussion may be a good place to start, you should follow up by providing notice in writing. There are several reasons for this.

1. Documentation. The written notice creates a record of the issue, which may be necessary for legal or auditing purposes. It also helps ensure that both you and the employee have a clear understanding of the situation.
2. Transparency. Providing a clear explanation of the error and the amount to be recovered helps maintain transparency and trust between you and the employee. It shows that you are addressing the issue professionally and fairly.
3. Opportunity for review. Giving the employee a written notice allows them to review the details of the overpayment and verify that your calculations are correct. This can help prevent potential disputes or misunderstandings.

When drafting the written notice, make sure to include:

• A clear explanation of the error that led to the overpayment
• The exact amount of the overpayment
• The pay period(s) affected
• Reference to relevant state laws and company policies
• A request for the employee to contact you to discuss repayment options
• Your contact information

To make it easy, here’s an example for a payroll overpayment letter. Note that this letter is just a sample to help you get started. Consult your local laws and obtain legal advice before attempting to recollect overpaid wages.

Template: How to Inform an Employee That They've Been Overpaid

Step 4: Discuss Repayment Options with the Employee

After you’ve informed your employee of the error, you’ll (hopefully) be able to work together to establish a repayment plan. Create a plan that is fair and manageable for both parties, and won’t place undue financial burden on your staff member.

Keep in mind that money is often an uncomfortable subject. Your employee may not want to be completely transparent about financial struggles or living expenses. When creating a plan, consider the following:

• Financial impact. Ensure that the repayment plan won’t cause undue finanical hardship for the employee.
• Timeframe. In many cases, you’ll need to spread the repayment plan out over several pay periods. A longer repayment period may be necessary for larger overpayments
• Frequency. Determine how often the repayment will be collected. For example, if you pay your employees on a biweekly basis, it may be easier for the employee to make monthly repayments.
• Repayment methods. Many employers will deduct the overpayment from a worker’s future wages. However, discuss the preferred repayment method with the employee.

Possible repayment options include:

• Lump-sum payment: The employee repays the entire overpayment amount in a single payment. This option may be suitable for smaller overpayments or if the employee has sufficient savings to cover the amount.
• Payroll deductions: Deduct a portion of the overpayment from the employee's future paychecks until the full amount is recovered. This option allows the employee to repay the overpayment gradually and may be more manageable for them.
• Combination: A combination of lump-sum payments and a payroll deduction may be used, depending on the employee's financial situation and preferences.

Once you and your employee come up with a plan, document it in writing. Provide a copy of this document to the employee. This will help to avoid misunderstandings and ensure both parties are aware of their obligations

Step 5: Adjust your payroll

After being sure to comply with state regulations and agreeing on a repayment plan with your employee, you’ll need to adjust your payroll records.

One essential step is addressing tax implications. Because overpayment can result in excess tax withholdings, you’ll need to adjust your tax liabilities. You may also need to file amended payroll tax forms with the appropriate agencies.

Other Solutions

In some cases, you may decide that recollecting wages just isn’t an option. In that situation, you’ll have 2 options:

• Don’t do anything. When the time and resources needed to collect repayment outweigh the loss, it’s probably best to let the overpayment slide.
• Overpay everyone. When an overpayment results from a systemic error (like incorrect pay rate), you can consider adjusting everyone’s pay to match.

Only consider these options if it’s financially viable for your business, and if you believe it’s the right thing to do

How to Prevent Overpayment

Want to avoid recouping payment from an overpaid employee? If so, it’s best to implement some safeguards against the overpayment of wages before they have a chance to happen.

Again, the most common causes of overpayment are 1) complex pay scales, 2) missed clock-outs, 3) human error, and, 4) miscommunication. Using standardized pay rates and training your staff on payroll procedure can help.

Timekeeping software is one way to reduce the likelihood of overpaid wages. For example, a good web-based time clock like OnTheClock can make your payroll both streamlined and highly accurate.

Our time clock includes features like overtime alerts and punch reminders to reduce the occurrence of missed clock-outs. Still, mistakes can happen — which is why it’s easy to review and correct time card errors when they happen.

It’s also easy to export our time cards to payroll software used by small businesses. That means you confidently can complete payroll in just a few clicks.

Ready to give it a try?