Everyone knows what a payday advance is, but do you know the best way to handle it for your small business? We’ll explain how a payday advance should work and how to avoid potential problems.

We can all go through a difficult time. A car that suddenly stops working or an unexpected illness can drain our savings quickly. This is where a payday advance can come into play.

Are you prepared if your employee asks for a salary advance? Do you have a policy and guidelines in place to prevent abuse and ensure the advance is repaid promptly?

Remember that business owners are not required to offer a payday advance to their employees. However, if you’re okay with offering your employees an advance, you’ll need to create a solid payroll advance policy first, so that when (not if) an employee asks for an advance, you’re ready.

Presentation: What is a salary advance?

A payday advance is a short-term loan that you give to your employees, with the agreement that the loan will be repaid using future wages earned. Depending on the agreement you create with your employee, a payday advance has specific terms that you, the employer, and your employee will need to meet.

How a payday advance works

Your employee must request a salary advance in writing. If an employee comes to you with a request for a payday advance, the first thing to do is ask them to put their request in writing, to create a paper trail from the initial request to the agreement and repayment plan. .

A written agreement must be part of any payday advance, with the agreement signed by you and the employee receiving the payday advance before processing payroll.

The salary advance application sample can be customized to suit your needs. Image source: author

A payday advance should be processed separately from your regular payroll processing, an easy task if you use payroll software or a payroll service provider. If you manage payroll manually, you will need to write a separate check to your employee to cover the advance.

You will then need to deduct the agreed-upon payments from your employee’s next paycheque, continuing to do so until the advance has been paid in full. You can easily do this using payroll software or a payroll service.

Always report any salary advances given to an employee in your payroll records, as well as all reimbursements.

The wrong way to handle a payday advance

Rachel has three employees. One Monday morning, Bob, one of Rachel’s employees, approaches her to ask for an advance.

There is nothing in the employee handbook regarding advances to employees. After a moment of hesitation, Rachel accepts a $350 payday advance loan. Rachel and Bob agree that he will repay the advance of his next four checks.

Rachel writes a check advance to Bob for $350 later that day.

The next day, Bob doesn’t show up for work and never comes back, leaving Rachel with $350. She can deduct some of the money from Bob’s final check, but since he only worked one day, that doesn’t cover the advance, leaving Rachel over $300.

The right way to handle a payday advance

Jim has a staff of five. One Monday morning, Sara, one of his employees, approaches him, asking for an advance. Jim asks the employee to put the request in writing.

Within an hour, Sara returns with her written request. Although she asked for $500, Jim only offers an advance of $250, the maximum advance offered by the company. He presents Sara with an agreement that includes the amount of the advance and the repayment schedule. The agreement contains a section on how unpaid advances will be handled if an employee leaves before repaying the full advance.

Sara reads and signs this agreement before Jim provides her with the advance. After Sara signs the agreement, Jim signs it, making a copy for himself and placing a copy in Sara’s personnel file, along with his original advance request.

How to avoid problems with a payday advance

Payday advances can be a lifeline for an employee who is having financial difficulties. But without clear guidelines in place, they too can be easily abused, with employers paying the price.

If you offer payday advances to your employees, it is important that you establish payday advance guidelines that must be followed by all employees without exception. These policy guidelines should then be incorporated into your payroll management processes and provided to your employees as part of an employee handbook. If you don’t have an employee handbook, the policy guidelines should be distributed in a separate document.

If you want to offer payday advances to your employees, but want to avoid legal missteps, consider these steps.

1. Specify eligibility

Are all of your employees eligible to receive a payday advance, or do you want to limit eligibility to full-time employees only? What about employees on probation? Can they receive an advance?

It is important to provide these details when creating your payday advance policy and apply them equally across the board, regardless of the circumstances.

2. Frequency of advances

You may want to limit the number of advances employees can receive. Some companies limit advances to one every six months, while others may limit advances to two per year. You may also consider adding a clause prohibiting an employee from receiving a second advance if the first has not been repaid in full.

3. Set a ceiling

It is important to set a cap on the amount an employee can receive and include this cap in your policy.

4. Don’t bend the rules for an employee

You have rules in place for a reason. If you circumvent or violate these rules for an employee, you create a situation where you can be sued for discrimination.

For example, George approaches his employer, Ben, for a salary advance. George and Ben are good friends outside of work, so Ben accepts a $700 advance, even though company policy states that advances are capped at $500.

Lucy, who approached Ben a month ago for a $600 advance, and only received $500, per policy rules, finds out about George’s advance and threatens to sue Ben for discrimination.

The lesson here is that even if this is your business, if you have a written policy, that policy must be followed at all times or you could end up in serious legal trouble.

5. Always complete a written agreement

Once you agree to provide a payday advance, you will need to create a written agreement, with all the terms and conditions of the advance spelled out in clear terms. The agreement should include the amount of the advance, the repayment terms, the amount to be deducted each pay period, and when deductions will begin and end.

You and your employee must sign the salary advance agreement, with a copy of the agreement also placed in the employee’s personnel file.

6. Don’t tax upfront

Payroll tax deductions should be deferred until your employee begins repaying the payday advance they received. Include the reimbursement amount when calculating and accumulating payroll for future pay periods.

7. Set up a repayment plan

Having a repayment plan in place in your payroll system ensures that you won’t forget to deduct the loan amount from your employee’s paycheck. If you’re not sure how to add a payroll deduction, your payroll service provider can help.

The New Deduction screen in QuickBooks Online Enhanced Payroll allows you to create a new payroll advance deduction. Image source: author

Should you offer payday advances?

Not all small businesses are able to offer a payday advance to their employees.

However, if your company can offer payday advances, it is imperative that you create a clear payday advance policy and always follow the rules, regardless of the employee or the circumstances.