An employee is overpaid… now what?

With $865 billion paid in annual wages and benefits to Canadians, it’s only logical that occasionally, someone, somewhere, might make a mistake. Payroll errors happen and they’re never pleasant. Informing an employee of an overpayment and trying to recoup those funds has to be one of the most uncomfortable experiences. 

And when it comes time to fill out and file T4s, the headache only grows. Where does an employer even begin?  

Take the example of an employee who takes an advance on his vacation time and then decides he wants to stay in the Bahamas and open a surf shop. Can his employer get back those two weeks of unearned vacation pay? 

What about when a marketing director realizes she is not entitled to receive her salary and disability payments simultaneously? Does the employer have any recourse? 

The Canada Revenue Agency (CRA) refers to instances like these as a failure to perform duties. The employer’s Canada Pension Plan (CPP) and employment insurance (EI) contributions are non-refundable, so the employee should be asked to repay the gross overpayment amount. 

Employers must not make changes to payroll records or tax slips — instead, they should give the employee a letter that includes when and why the overpayment was made, as well as what repayment was received. An employee can then deduct that amount on line 229 of his personal tax return.

And if the employee is a former one, like the surf shop owner? Write a cordial letter explaining the situation. In most cases, ex-employees will be happy to comply but if not, a record of this initial contact will help should an employer take legal action.

Here, things get a little more complicated. But mistakes happen, particularly if payroll still involves manual or double data entry.

If the error resides with management or payroll, employers may choose to allow the overpayment. In that case, employers should add the amount to the employment income for the year that the debt was forgiven. 

Employers can also make arrangements directly with the employee to have the amount repaid. The question of “how much” seems like a simple one but, as with most things payroll-related, it depends on the circumstances. 

If an employee makes the repayment in the same year the error was made, she will only have to pay the net amount, provided her employer reduces the next CRA payroll remittance to recoup CPP, EI and income tax deductions erroneously filed. These corrections must be made before the last remittance of the year is submitted.

An employee will repay the gross amount if:

• the repayment is made in a different tax year than the overpayment

• no CPP, EI or income tax deductions were made

• the employer cannot reclaim those deductions before the end of the year.

Either way, payroll records must be altered and the T4 slip must be fixed and reissued.

When an employee doesn’t fully understand the situation or is simply being recalcitrant, it is difficult to know how to respond. 

In many jurisdictions, employers cannot deduct overpaid wages without formal consent from the affected employee. When an employee refuses to pay back the amount owed, the employer should include it in employment income of the year the overpayment was made. If an employee agrees to make a repayment but fails to do so, add the overpayment to the employment income for the year the promise was made. 

But first, employers should know their rights. Rules on recouping repayment from employees vary by province and between different kinds of compensation. Generally, payroll cannot deduct overpaid vacation pay without having a written and signed policy. 

It is also considered best practice to get an employee’s written permission prior to making a deduction, since the relevant legislation can and does change.

Federal: The employer may deduct an overpayment from regular wages or vacation pay.

British Columbia: The employer may deduct an overpayment from regular wages, with written permission. To legally deduct from vacation pay, the employer must already have a written and signed policy to that effect.

Alberta: The employer may deduct an overpayment from regular wages or vacation pay, with  written permission specifying the exact dollar amount. 

Saskatchewan: The employer may deduct an overpayment from regular wages, so long as the correction is made in the next pay run. To legally deduct from vacation pay, the employer must already have a written and signed policy to that effect.

Manitoba: The employer may deduct an overpayment from regular wages without the employee’s consent. The correction must be made as soon as possible, otherwise it can be assumed the employer has approved a wage increase. To legally deduct from vacation pay, the employer must already have a written and signed policy to that effect.

Ontario: The employer may deduct an overpayment from regular wages. To legally deduct from vacation pay, the employer must already have a written and signed policy to that effect.

Quebec:  The employer may deduct an overpayment from regular wages, so long as it can prove an overpayment was made. To legally deduct from vacation pay, the employer must already have a written and signed policy to that effect.

Newfoundland and Labrador: The employer may deduct an overpayment from regular wages or vacation pay.

New Brunswick: The employer may deduct an overpayment from regular wages, so long as the correction is made within one year. To deduct from vacation pay, the employer must already have a written and signed policy to that effect.

Nova Scotia: The employer may deduct an overpayment from regular wages, provided this does not drop the employee’s earnings below minimum wage. To legally deduct from vacation pay, the employer must already have a written and signed policy to that effect.

Prince Edward Island: The employer may deduct an overpayment from regular wages, with written permission. The employer may deduct an overpayment of vacation pay without written permission.

Northwest Territories/ Nunavut: The employer may deduct an overpayment from regular wages, so long as written permission is obtained. To legally deduct from vacation pay, the employer must already have a written and signed policy to that effect.

Yukon: The employer may deduct an overpayment from regular wages or vacation pay, so long as written permission is obtained.

Between informing employees and complying with the CRA, overpayments are far from fun. The best method is prevention, so if employers find themselves adjusting T4s over and over, it just might be time to review payroll processes.