5 Things to Know About Employee Cash Advances

pile of dollar bills
In an effort to combat what is perceived as unfair lending in the cash advance market, some employers offer workers cash advances against their pay. These cash advances are short-term loans for all intents and purposes. They meet the need for emergency cash without locking employees into high-interest loans offered by online and retail lenders.
Whether or not a company offers cash advances is strictly up to ownership and management. However, certain laws must be followed the minute a company crosses into that territory. We recommend against cash advances until such time as ownership and management fully understand what's involved. To that end, below is a list of five things to know about employee cash advances before offering such a benefit.

Federal and State Approval

The first thing to know is that federal law does allow employers to advance cash to employees against future paychecks. Federal law is okay with the practice even if a cash advance would cause an employee's pay to fall below the minimum wage at the next payroll run. Most of the states follow Washington's lead on this.
Where state laws differ, it is up to employers to know what is expected of them. An employer considering offering a cash advance benefit should check state labor laws just to make sure it is allowable.

Wages Are Still Taxable

Next, the government considers the cash advance regular income. As such, it is taxable. The question is when taxes should be withheld. The general rule is this: the employee receives the full value of the cash advance without any taxes withheld. At the next payroll run, taxes are calculated based on the entire amount earned for that pay period irrespective of how much was received in the advance.
Let's say you have an employee requesting a $200 cash advance against his next $700 paycheck. Taxes are not withheld from the advance. On the next payday, taxes are withheld on the entire $700 despite the fact that the employee will only receive a $500 check to account for the cash advance.

Recoverable Commission Advances

Employees who earn commission can request advances against it. There are two ways to set up this sort of advance, beginning with a recoverable advance. This is a cash advance given in anticipation of repaying via commissions. Money is deducted from commissions until the cash advance is paid back.

Non-Recoverable Commission Advances

In a non-recoverable situation, an employer agrees to a cash advance against future commissions with the understanding that it will only be paid back if the worker's commissions exceed the amount of the advance. No repayment is necessary if the employee does not earn enough commission to do so.
This kind of cash advance is risky in that it might encourage employees to not do what is necessary to earn maximum commissions. Not having to repay the cash advance could be more profitable in the long run. So employers have to be very careful here.

Taxable Interest Rates

Finally, a cash advance is essentially a loan provided by the employer. Federal law requires that interest rates be looked at for the purposes of taxation. Let's say the prevailing rate on a personal loan is 5%, yet the employer chooses to offer a cash advance at 2%. The 3% difference is considered income by the IRS. Employers must calculate the total value of the difference in interest rates and withhold taxes on that amount.
Cash advances are something your accountant or payroll processor can help you with. If you would like to know more about full-service payroll solutions, feel free to contact BenefitMall.