I Want My Money Back: A Primer on Recovering Inadvertent Overpayments

A common conundrum for employers is what to do when they accidentally overpay employees. Even the most diligent employers are not immune from inadvertent overpayments, especially when grappling with an increasingly complex landscape of compensation processes and systems. Perhaps the most frequent causes of these inadvertent overpayments are simple clerical errors. These come in a variety of forms. For instance, a manager might accidentally send the same timekeeping file to payroll twice, resulting in double payment. Other common causes include typographical errors (e.g., adding an extra zero where it didn’t belong), inadvertent miscalculations, or accidentally shifting a payroll file to create a mismatch between lists of employees and their corresponding payments. Regardless of the reason for the mistake, the result is the same: the employer inadvertently pays an employee (or many employees) funds to which they were not entitled.

When an inadvertent overpayment is discovered, an employer may be tempted to simply notify the employee and deduct the amount of overpaid funds from the employee’s next paycheck. No harm, no foul, … right? Unfortunately for employers, recovering overpayments is not so simple.

State Laws Implicated by Overpayment Recovery Deductions

First and foremost, there is the patchwork of state wage and hour laws that govern an employer’s right to take deductions from wages. While most jurisdictions do not explicitly address whether and how employers may deduct from employees’ wages to recover overpayments, many states do, and these laws vary widely.

In New York, for example, employers must comply with specific rules when attempting to recover inadvertent overpayments via wage deduction. New York restricts the timing, frequency, and amount of the deduction. While New York does not expressly require the impacted employee to provide written authorization of a deduction, state law does mandate that the employer provide advance notice of the deduction and give the employee an opportunity to challenge the overpayment and terms of recovery, among other things.¹

In contrast, the California Department of Industrial Relations contends that deductions to recover overpayments are unlawful under the California deductions statute unless the employer and employee enter into a written agreement, the employee voluntarily consents to the deduction, the deduction does not exceed the agreed-upon amount, and the deduction does not cause the employee’s pay to fall below the minimum wage in any pay period. Even if all these requirements are met, the Department insists that such deductions may not be taken from an employee’s final wages.²

Many other jurisdictions place limitations or conditions on overpayment recovery deductions. Some states limit the amount of the deductions (e.g., precluding deductions that would bring an employee below minimum wage or take from their earned overtime compensation, or capping the deduction at a specified percentage of the employee’s earnings in a pay period).³ Others impose restrictions on the timing of the deduction (e.g., prohibiting deductions if too much time has passed since the inadvertent overpayment).⁴ Still others require that the employee expressly authorize the deduction in writing at the time the deduction is taken.⁵

Notably, some states expressly allow deductions to recover overpayments that are the result of a bona fide error.⁶ Still others do not even consider overpayment recovery to be a “deduction” at all and therefore exempt the adjustment from laws governing deductions. For instance, under Hawaii law, adjustments in wages for the purpose of “correction of computation errors from previous payrolls” are not considered “deductions” under state law.⁷ While Pennsylvania law is silent on the issue, the Pennsylvania Department of Labor & Industry opined that in the event of a one-time inadvertent overpayment that is promptly investigated, the overpayment will be viewed as an “advance” of wages such that the subsequent adjustment is not considered a deduction under the Pennsylvania Wage Payment and Collection Law.⁸

Practical Considerations When Recovering Inadvertent Overpayments

When an inadvertent overpayment was made by direct deposit and is discovered quickly, the employer may be able to reverse the payment, thus avoiding the “deductions” issue altogether. Reversals are only allowed in limited circumstances, however, including inadvertent duplicate payments and incorrect payment amounts. Typically, the reversal must occur within five banking days of the transaction settlement date. Moreover, the employer must notify the employee of the reversal and the reason for it by the settlement date of the reversing entry. Finally, the reversal must be for the entire, exact amount of the original transaction. Thus, reversal is not a recommended solution where the employer owed a portion of the amount on the original payment date, since reversing the entire transaction and then making a correction payment could render the corrected deposit untimely.

If reversal is not an option, employers will need to navigate the labyrinth of state deduction laws to ensure a compliant approach. Employers may struggle to find a “one size fits all” solution due to the myriad state laws in this area. Instead, employers may want to consider developing a general “starting point” that is consistent across the country, while retaining the flexibility to deviate (subject to state law considerations).

For example, it may be prudent in all states (even those that don’t impose rules on overpayment recovery) to provide written notice to the employees of the inadvertent overpayment (including the reason, date(s) of overpayment, and amount) and to request that the employee agree to repay the amount voluntarily. Perhaps the employer could give the employee options for making the repayment, such as repaying the amount by separate transaction (i.e., writing a check back to the company), authorizing a lump sum deduction from the next wage payment, or spreading out the repayment across multiple paydays. Since some states place limits on the amount that may be deducted from any one wage payment, the employer will also need to decide whether to apply those limits nationwide or only in the states where a cap is required. Even these seemingly innocuous options may be subject to legal challenge in certain states. Whatever solution the employer considers should be evaluated for compliance with the laws in any state where the recovery will be attempted. 

If an employee refuses to provide the requested authorization within a reasonable period, the employer will need to decide whether to proceed unilaterally to take the deduction, at least in those states where authorization is not required. In the alternative, an employer may want to consider negotiating with the employee, offering to recover the net (post-tax) amount of the overpayment or some other discounted amount. As a last resort, the employer will need to decide whether to pursue litigation (or arbitration) against the employee for their unlawful retention of funds to which they were not entitled.

Final Thoughts

Navigating all the legal requirements and practical considerations related to recovering inadvertent overpayments can be daunting, and there is often no one-size-fits-all solution. Employers with questions about how to recover inadvertent overpayments should work with experienced counsel to make sure they consider all relevant issues in their decision making.