If an employer makes an overpayment, does employee have to give money back?

Overpayments are almost as common as underpayments, but it can be awkward asking an employee to return excess cash. Here's a step-by-step guide to navigating this payroll error.

Imagine overpaying an employee by almost $100,000 in a single payroll transaction.

This happened to an Australian government body when a single payroll error meant a public servant was paid an extra $93,771.

Overall, the employer discovered it had overpaid its employees by $3.6 million in the 2020-2021 financial year, sending departments running to prevent future mistakes in the system.

This kind of oversight might seem unusual, but it's far more common than employers might expect, says Tracy Angwin, CEO of the Australian Payroll Association.

"Overpayments are almost as common as underpayments," she says. "Normally, we are engaged to do compliance checks on an employer's payroll because they think they have an underpayment. But in 70 per cent of the work we do, we find overpayments.

"The reasons are exactly the same: the wrong decisions have been made, the system was set up incorrectly, or there are poor processes. Sometimes, a 'set and neglect' mentality means the payroll system is set up and no one ever looks at it again - until they find out someone has been overpaid."

How to recoup an overpayment

According to the Fair Work Ombudsman, an employer can only deduct money from a worker's pay packet if the employee agrees in writing, and it is principally for their benefit - such as organising a salary sacrifice arrangement or additional payments into their superannuation fund.

  • One of the following criteria must also apply:
  • It is allowed by law, a court order, or by the FWC.
  • It is allowed under the employee's award.
  • It is allowed under the employee's registered agreement and the employee agrees to it.

The Ombudsman states that an employer cannot deduct money if it benefits the employer either directly or indirectly and is unreasonable in the circumstances, or if the employee is under 18 years of age and their parent or guardian has not provided written agreement.

In other words, the set of circumstances that enable an employer to recoup an overpayment are very specific and can put employers at legal risk if not handled properly.

"You've got to be really careful," says Angwin. "It's not as simple as saying to a worker, 'I overpaid you $100. I'm going to deduct the $100 out of your next pay.'

"We strongly advise employers not to deduct the overpayment from the following pay period - not only because it's illegal, but also because it can affect tax and create other complications."

Instead, prioritise open communication with employees to explain the scenario, apologise for any inconvenience caused, and delineate what action is being taken to prevent the situation from recurring.

It's also essential to know when the overpayment occurred; the procedure for an overpayment made in the current financial year differs from what would happen if the error occurred in the previous financial year.

"If it's in the current financial year, the employee only needs to repay the net amount of the overpayment," says Angwin.

Simple enough. But say you find out in July that you made an overpayment in May - what happens then?

"The employee would repay the gross amount, and the pay office needs to adjust the details in payroll for that financial year and reissue the income statement," she says. "The employee then needs to resubmit their tax return to recoup the tax portion of the overpayment."

"Sometimes, a 'set and neglect' mentality means the payroll system is set up and no one ever looks at it again - until they find out someone has been overpaid." - Tracy Angwin, Australian Payroll Association

So how can an employer go about seeking the return of the excess cash?

"If an employee does agree to make the repayment, it's best not to do it through payroll," she recommends. "Organise a separate payment to the employer from the employee - and have payroll reconcile that."

HR should also be prepared for when an overpayment has been detected only after the employee has spent some or all of the money. In this scenario, the same process of making an agreement for reimbursement applies, says Angwin.

Also, it might not be financially reasonable to ask a worker to repay the money in one go - for instance if the repayment exceeds or matches an employee's income - meaning an employer might need to accept smaller repayments over time rather than a single lump sum.

But what about if an employee refuses to return the amount that has appeared in their account?

"In the event that your employee does not cooperate, which they're entirely able to do, you need to go through the normal process of debt recovery as you would with anyone who owes you money," she says.

Prevention strategies

Navigating overpayments can seem daunting, but Angwin is quick to reassure HR that the solutions are close at hand.

"Like most things in payroll, there's a simple way to get through it," she says. "You just need access to the right information and advice.

"Ensure your payroll team has somewhere to go to get answers quickly to all their payroll questions. At the end of the day, they are the ones making these decisions, and they don't necessarily come to HR for guidance every time."

This repository could compile legal advice, company regulations, cheat sheets and templates in a single location for ease of access.

Investing in training for your team will also pay off in the long run.

"I talk ad nauseam about payroll qualifications," she says. "Make sure that the people who are actually doing the payroll are trained regularly - you want to be sure they identify these issues early."

Angwin also recommends instituting regular compliance audits.

"Get third-party eyes looking at your payroll process every couple of years," she says. "I'm talking about a payroll compliance audit by a payroll expert, looking at the payroll process, your payroll team and whether they are qualified to do the job, and the setup of the payroll system."

After all, it could be as simple as a box being checked or left unchecked that causes a significant financial error.

That's why it could pay to automate the payroll system itself, ensuring employees are meeting their hourly commitments, not working to excess, and being paid fairly for hours worked.

In addition to eliminating human error, automation frees up HR and payroll personnel to benefit the business in other ways, such as process controls, reconciliations and engagement strategies.

A step-by-step guide to managing overpayments

To make it simpler, Angwin provides a condensed rundown of actions that employers can take if an overpayment has occurred:

Step 1: "Identify which financial year in which the overpayment occurred."

Step 2: "Make an agreement with the employee about how much they're going to pay back and over what period of time."

Step 3: "Arrange for the employee to make those repayments directly to the employer. Do not deduct from the employee's pay."

Step 4: "Make any adjustments in the payroll that are required and/or reissue the income statement, and have the employee re-do their tax return."

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