Helping an employee with an immediate financial need is a virtuous act that promotes loyalty – especially with a small staff. But widespread misunderstanding surrounds advancing funds for which future repayment is deducted from compensation. When employees turn to you for payroll advances to meet their unexpected cash needs, be sure you understand the impact of turning your business into a lender.
When word gets around that the company has funds for advances, many will step forward with requests. Awkwardness is certain to arise if some requests are granted and others are declined. Moreover, when an employee departs the company before debt is repaid, your ability to collect the loan is significantly impaired. Lending to an employee also commonly leads to ongoing future requests from the same individual. To thwart this uncomfortable pattern, an entrepreneur may simply make a one-time gift to an employee. This special measure of gratitude has clear financial limits that deter future exploitation. Staff gifts are generally accounted for as payroll wages expense. Employment taxes are applicable and the transaction is typically treated like any paycheck.
Establish a written program for employee loans that specifies qualifications, maximum amounts, and repayment terms. Failure to establish guidelines could open your business to claims of unfair or illegal discrimination. Employee loans are distinguished from an advance against the very next paycheck. Long-term arrangements should be solidified in writing with an interest-bearing promissory note executed by the employee. These promises for repayment are business assets, not expenses. Your bookkeeping merely shows less cash asset and more notes receivable asset.
The Finance Writer 