If there is one "chore" that all employers have in common, it is processing the employee payroll. Like the calculation of compensation, the withholding and/or deduction of money from an employee's paycheck is also heavily regulated by federal and local regulations. The following summary provides basic tips on how to perform withholdings and deductions from employee paychecks.
Deductions Required by Federal and State Law
By law, employers must deduct social security taxes (FICA) and wage withholding taxes (income taxes) from employee paychecks. The deductions are made on the amount of wages that are actually or constructively paid to any employee, at the time of payment. Employers who fail to deduct the required taxes are liable for the amount of tax that should have been withheld, plus penalties and interest on the amount.
Deductions Required by Court Order
Federal and local laws allow third parties to file legal claims against an employee's wages and, upon receipt of a court order, require the employer to deduct appropriate amounts from the employee's wages and pay these amounts to the third party. These deductions are made from the employee's "disposable income" which is calculated by deducting the employee's employment taxes from his/her gross pay. There are five basic types of court-ordered deductions:
- Child and spousal support payments (which cover spouses who have custody of the couple's children);
- Support payments for a spouse (alimony);
- Tax levies;
- Federal student loans; and
- Garnishment by other creditors.
The specific procedures for handling court-ordered deductions depend upon the nature of the claim. However, in general, court-ordered deductions involve:
- A court order requiring the employer to withhold a specified sum from the employee's paycheck;
- Service (delivery) of the order to the employer;
- Withholding of the specified sum by the employer; and
- Transmission of the withholding back to the court.
If anything happens that affects the employee's income, the employer must immediately report the change to the court and await instructions. Regardless of what happens, an employer must continue to make the appropriate withholdings from the employee's paycheck until it receives a court order terminating the payments. Failure to comply with a withholding order can result in a court proceeding for contempt of court. Employers who fail to withhold may also be liable for the amounts due but not withheld.
The maximum amount that may be deducted from an employee's wages, salary, stipend or commissions is generally controlled by local law and federal law. You should check with your accountant or attorney for information on the current maximums.
Under Hawaii and Guam law, deductions which are not required by law or court order must be authorized in writing by an employee before they can be deducted. Such deductions include, but are not limited to: employee contributions for medical, dental, disability, life or other insurance premiums; contributions to retirement plans; charitable contributions; union dues, fees and assessments; contributions for uniforms or equipment; reimbursement of pay advances or employee loans; or repayment of wage overpayments. The written authorization should specify:
- The purpose of the deduction;
- The exact amount of the deduction; and
- The date or circumstance upon which this authorization to deduct will expire.
If an employee fails or refuses to provide a written authorization, the employer may not deduct the sum. Deductions, absent written authorization, will subject the employer to civil fines equivalent to the amount of "unpaid wages", plus interest.
Even if an employee agrees to provide a written authorization to deduct sums from his/her pay check, there are other rules restricting certain types of deductions. (For example, Hawaii and Guam law prohibits employers from deducting "fines" from employee paychecks.) Employers cannot get around these prohibitions by requiring employees to write a check or pay cash for the amount, in lieu of payments through payroll deduction. Violation of these provisions may result in civil penalties equivalent to the unpaid wages, plus interest. You should check with your legal counsel for the current list of prohibited deductions under state (or territory) law.
Minimum Wage Considerations
The federal Fair Labor Standards Act ("FLSA") also contains restrictions on payroll deductions. Deductions which are made for items that "benefit" the employer (other than the reasonable cost or fair market value of board, lodging or other facilities customarily furnished to the company's employees), are not permitted to the extent they reduce an employee's cash wages below the statutory minimum wage during a non-overtime week. Examples of such items include, but are not limited to dry-cleaning costs associated with company uniforms and tools which are required for the employee's job. Deductions for such items can be made during weeks in which the employee earns overtime compensation, but only to the extent such deductions do not exceed the amount the employer could deduct in a non-overtime week.
If an employer mistakenly pays an employee too much during a particular pay period, and the employee is a minimum wage earner, the employer may not recover the overpayment through payroll deduction unless the employer: (a) obtains a judgment against the employee and a garnishment order against the wages; or (b) waits until the employee's pay rises above the minimum wage and deducts the amount overpaid from the "excess."
The foregoing summary only provides information on the general rules for payroll deductions. There are also procedures for handling special situations such as: tax withholdings for non-resident aliens; settlement agreements; garnishment of government employees; processing of out-of-state (or off-island) garnishment orders; multiple orders for deductions and how to prioritize the various orders; and bankruptcies. Again, check with your accountant and/or legal counsel for assistance in these areas.
The bottom line for payroll deductions is:
DO NOT LET CHILD SUPPORT ORDERS, TAX LEVIES OR GARNISHMENT ORDERS SIT!
Act on the papers immediately. There are strict time frames during which you must respond. The papers you receive when you are "notified" of the garnishment order contain a lot of information. Read the papers. If you still don't understand, call the agency or court and ask for clarification. Most agencies and courts will answer questions about their procedures. If, for some reason, you still cannot get an answer, call your attorney and/or tax consultant.