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Overpayment Of Wages – What To Do?

Paying too much to employees

Owning businesses is complex, and sometimes, payroll errors are inevitable – the most common of which is overpaid wages. Whilst overpaying an employee’s wages sounds like a good problem for them, it’s technically unfair to their co-workers and the company. But how do you contend with overpayment of wages? Can you get the wages back?

In this article, we will explore what constitutes overpaid wages, the legal proceedings surrounding the possibility of recovering it, and the overall best practices to employ to find the best outcome for everyone involved.

What Are Overpaid Wages?

It sounds like a simple enough concept, but legally, it’s important to have a standard definition. Overpaid wages mean that an employee has received more wages than they are entitled to as per their contract. Meaning, that the payment is not parallel to the amount of hours worked, applicable bonuses and agreed salary.

How Do Overpaid Wages Happen?

  • Payroll Errors – The most common factor in the overpayment of wages is a payroll error, meaning the data entered was incorrect or miscalculated. Sometimes, glitches within the software itself can cause payroll errors, which is by far the most aggravating cause.
  • Incorrect Hours Worked – Either incorrect calculations of hours worked, misreported hours, errors in overtime calculations or incorrect processing of leaves/absences can result in this important part of the equation being wrong, resulting in the overpayment of wages.
  • Administrative Mistakes – Administration can be complex, and various errors can lead to overpayments, such as failure to adjust salary following promotions, or miscalculation bonuses.

Payroll Error Employee's Wages

Legal Action – The Employment Rights Act 1996

The Employment Rights Act of 1996 (ERA) is the main legal aspect you’ll be contending with, regardless of their employment relationship (whether this is a current or former employee).

The ERA addresses overpayment of wages through its provisions on unlawful deductions of an employee’s wages – set to protect both employee and employer.

  • Express provision vs Implied term
    • Express provision – All employees have an employment contract, and there should be a statement within that outright states whether or not you reserve the right to recover overpaid wages.
    • Implied term – Without an explicit clause, there’s still some hope, as overpayments are considered an implied term – meaning even if it’s not outright stated, the nature of the employment usually implies that you reserve the right to collect monies owed.
  • Unlawful Deduction – The ERA prohibits deductions of an employee’s wages except in specific circumstances. This is relevant if the employee refuses to return the excess money, as overpayment issues are one of the conditions that provide an exception. This effectively means that you can deduct from the future wages of the employee to return the overpayment of wages. This can be from any source, whether a final salary payment or statutory payments (such as sick pay).
  • National Insurance and Tax Implications – Unfortunately, overpayment of wages can boost the amount of NICs and income tax the employee pays. This means you’ll have to remedy it by effectively refunding the employee the excess NIC and income tax.

 

How To Recover Overpaid Wages

To recover overpaid wages means balancing the assertion of your company’s finances, and maintaining positive relationships with your employees.

The following is a step-by-step guide to navigating this issue:

  1. Investigation and verification – Before you take action, review relevant documents and record the information that proves the miscalculation in payment. Keep it comprehensive and as simple as possible, as well as accurate. Get assistance from your payroll team or financial professionals.
  2. Open communication – After gaining the evidence, it’s important that you inform your employee as soon as possible. Delaying can lead to complications and misunderstandings. The longer the overpayment of wages goes unattended, the more likely the employee will feel entitled, or feel as if it’s a loss to repay the money. When you tell them, ensure they understand that it’s an unintentional error and how it happened. Then allow the employee to give concerns or questions, answering empathetically and in good faith.
  3. Agreement and Repayment Plan – The next aim is to find a repayment plan that is mutually beneficial, trying to ensure goodwill and cooperation. A flexible repayment plan is much more easily accepted than a lump sum payment, especially if it’s spread out over a long period, avoiding chances of financial hardship.
  4. Written agreement – Write out a formal agreement that illustrates clearly the overpaid amount and the agreed-upon repayment method, schedules, etc.
  5. Legal Action (when all else fails) – Employees who fail to acknowledge overpayment issues or their responsibility to pay it back can be hard to deal with. You can’t charge or force them, but you can take it in a couple of legal directions:
    1. Consult Legal Counsel – Specific advice from an employment law specialist will be able to tell you your best bet, as they understand your specific circumstances.
    2. Employment Tribunal or Civil Court – For small claims, initiate a claim through an employment tribunal. If it’s large claims, you will need to go make a civil court claim on a civil debt.

 

Bear in mind that if communications break down around the overpaid employee’s salary, then you should be aware that they can issue an internal grievance procedure. This is why it’s so important to ensure you have accurate documentation, including relevant passages of your employee’s contract.

Prevention Of Overpaying Salaries

The best way to recover outstanding debts is to not incur any at all on your end. This can be done through a proactive approach to payroll management, such as:

  • Robust Payroll Systems – Investing in reliable software that is heavily peer-reviewed and can conduct automated calculations, tax deductions and the like. Examples of good payroll solutions are Sage 50 Cloud Payroll and Xero. Using cloud-based software results in a 27% reduction in payroll processing errors, according to the American Payroll Association (APA) in their 2023 payroll processing benchmark survey. Ensure that you comply with all updates, too.
  • Double Check Calculations – Create a dedicated checklist that will check over all important payroll elements, such as salary, deductions etc., and ensure separate reviews to sign off on each calculation. This is an involved approach, but it can outright kill any chance of miscalculations as your fault. If this is too much, then consider ensuring your payroll scheme is using data validation rules, and flagging issues that the software sees, such as being paid for more hours than there are in a month.
  • Regular Payroll Audits – Internal audits being conducted annually is a recommendation made by the UK’s National Audit Office. These audits are not to check if incorrect payments have been made, but rather to identify weaknesses that you can action. External payroll audits are also a good idea, although there’s not much need to do it any more than once every few years.
  • Clear Communication with Employees – Ensuring that all who work for you know their salaries is a vital piece of ensuring that everyone knows what goes into their pay. This can be easily broken down using short videos or, an IT industry favourite – infographics. This can empower employees to find faults on their own, as the Chartered Institute of Payroll Professionals found that 80% of employees find payslips hard to understand.
  • Training for Payroll Staff – Payroll is not a static and simple job. Training costs may be high, but ensure that you always try to expand the skill and knowledge of the most vital roles in your company to incentivise boosts in efficiency and productivity. Some certifications, such as CIPP’s Payroll Technician and Payroll Administrator qualifications. A study by CIPP named “The Impact of Payroll Certification on Payroll Accuracy” found that companies with a higher percentage of certified payroll practitioners experience 30% fewer payroll errors than those with fewer certified staff.

Training Payroll Staff

Conclusion

Retrieving the overpaid amount of an employee is easier when you can easily retrieve your employee’s permission. Ensure that you hire employees who are both conscientious and understanding of a business’ need to change, and then ensure that you build goodwill with your employees, taking care of their needs and making their time at work worthwhile. Treating your employees like customers (internal customers) is considered a good practice that yields great results in the modern business world.

FAQ: Do I need to report overpayment to HMRC?

Yes, HMRC overpayment has to be reported to HMRC, because how much a person makes through wages has to be accounted for in tax and national insurance contributions. If the overpayment is discovered in the same tax year (6th of April to 5th of April the following year), then you can correct this through a Full Payment Submission (FPS). If it was discovered in the previous tax year, you will need to submit an Earlier Year Update (EYU).

Failure to report can result in several issues with HMRC:

  • Penalties – HMRC can impose several kinds of penalties on you if they find you failed to report an overpayment. These can range from adding fixed amounts to a percentage of tax, interest charges or even both.
  • Disruptions – Failure to report is seen as a failure to comply with HMRC regulations until it’s properly investigated. The investigation can easily cause disruptions to business.
  • Overpayment Reclamation – Actually receiving your overpayment back from the employee can be even harder once it’s discovered by HMRC that you failed to report it. HMRC could even act against you, ignoring your right to reclaim the lost money and thereby making it very hard. This is because they place the burden of responsibility on the business owner.

 

How do I report lost wages to HMRC?

How you report the miscalculation depends on the payroll software that you use. Thankfully, nowadays reporting to HMRC is a lot more straightforward and convenient for all parties involved, and most modern payroll systems have built-in functions that automate a lot of the work for you. But just because it’s automated and easy, doesn’t mean it’s any less imperative to report. Delays in reporting mean possible delays in retrieving the wages.

FAQ: Can I claim a tax refund if I’ve overpaid an employee?

No, unfortunately, you cannot claim a tax refund. Whilst this would be a very convenient, non-confrontational way to ensure you and your employees are covered, there is a very good reason why this is an impossibility.

In the HMRC’s eyes, the employee, through working, being paid, and having taxes calculated automatically outside of their control, is the one who has the right to claim a tax refund. The overpayment of wages was done by the employer, not the employee. The employee is considered the victim, whereas the employer, regardless of intent, is the primary party responsible.

FAQ: What evidence is required at an employment tribunal when seeking to recover overpaid wages?

There are many pieces of evidence depending on the circumstances of your case, and it’s best to have a lawyer lay these out if court action is on the table.

Regardless, here are some ideas:

  • Employee’s contract – The employment contract of your employee establishes the agreed-upon terms of employment and will reflect general expectations of salary, hours, bonuses etc. The more flexible your employee’s contract is, typically the harder it is to prove overpayment using this as evidence.
  • Payroll Records – Payroll records for the relevant period, including payslips, timesheets and other documents used in the calculation of payment can provide a good overview of an employee’s expectations.
  • Correspondence – Communications with employees regarding the payment, especially when discussing specific details about the overpayment, are a powerful tool in proving that too much was paid.
  • Witness – As the business owner, or anyone with management powers, you can call upon people who have worked alongside you to testify. This includes payroll staff and those who approved the amount by mistake.

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