What Happens When You Pay an Employee Incorrectly

Mistakes are an unfortunate business reality, but mistakes with payroll? Those are different—and potentially extremely problematic. Overpaying an employee results in financial losses, while underpaying them leads to employee dissatisfaction and legal consequences. 

These scenarios typically occur more frequently with hourly employees but can also happen to salaried workers. 

This article will guide you on how to handle the situation when you pay an employee incorrectly. It also includes a comprehensive FAQ section where you’ll find more information on the topic.

What Happens When You Pay an Employee Incorrectly: Overview

While there are some general rules of thumb to follow when it comes to rectifying incorrect payment, some states have their own laws surrounding the practice of getting money back from an employee when they are overpaid. 

Here are some examples:

• Washington: Requires written notice detailing the overpayment. Employees must repay within 20 days.
• New York: Allows recovery of overpayments from clerical errors within eight weeks of notification. Deductions are capped at 12.5% of gross wages per pay period.
• California: Requires notification and explanation. Deductions must not drop wages below the state’s minimum wage.

Before taking any action, it’s important to understand your state’s laws. 

Let’s revisit some general rules to follow in these situations. In the United States, there are common laws that must be followed.

Overpaying an Employee 

Most situations allow employers the right to regain over-payments, but, again, laws differ from state to state. In every occurrence, the employee must be notified of the error before any attempt to retrieve funds. 

Some employees will tell you if you've overpaid them, while others may simply not notice or choose not to alert you.

Having payroll records available is crucial in verifying the overpayment when discussing it with the employee.

You cannot request remuneration without valid proof. Most states allow employers to make deductions from a future paycheck that will cover the overpayment after the payroll department has effectively notified the employee.

However, some states do not. 

In Oregon, you must reach an agreement with the employee on how to have the funds repaid before proceeding. If the employee refuses to repay, you can legally sue. 

In Washington, employees must consent to a payroll deduction after being notified of the issue. They can also repay the amount via personal checks. Washington also allows employers to take legal action against workers refusing to repay them.

Remember to always adhere to federal and state minimum wage laws. 

You can't deduct from a future paycheck if that results in an hourly rate below minimum wage. In this situation, you are required to deduct from several future paychecks to abide by the law.

Are you familiar with how subject wages differ from taxable wages? Learn more in this article.

Underpaying an Employee

If you underpay an employee, begin the repayment process immediately. An underpaid employee has every right to demand their money back—as early as the next paycheck. 

Late payments accrue the longer you take to pay an employee back. If underpaying an employee is a consistent issue due to complicated local taxes or withholding rates, consider investing in a local tax identifier.

Document the error and have the employee sign off on the correction to confirm acknowledgement. 

According to the U.S. Department of Labor, employees generally have up to two years to take legal action if the problem is never corrected. If, for whatever reason, you intentionally underpay an employee, that employee has up to three years to act.

Maintaining meticulous records and ensuring that the software is functioning properly can help prevent penalties, employee dissatisfaction, and legal issues caused by payment errors. 

If any problems arise, these records will help you resolve them quickly and keep your business running smoothly. 

In Closing: Correcting Employee’s Wages

Payroll mistakes aren’t always avoidable, but how you handle them is within your control. 

This is an important task because overpaying or underpaying an employee can lead to compliance issues, strained relationships, and potential legal consequences if not addressed properly.

Understanding both federal and state-specific rules will help you correct payroll errors accurately. Other vital steps include keeping thorough records, acting quickly, and communicating clearly with employees.

Are you dealing with complex tax calculations? Multi-state or international compliance? Or recurring errors in your payroll process? Then, it might be time to upgrade your tools.

Symmetry provides accurate, reliable payroll tax solutions that help reduce errors and simplify compliance across all 50 states.

Get a Symmetry demo today to see how you can streamline payroll, improve accuracy, and avoid costly mistakes.

Keep learning about payroll best practices in these articles:

• Back to Basics: Paycheck Taxes
• The Importance of Location Accuracy in Payroll
• Six Mistakes Small Businesses Make When It Comes to Payroll

Frequently Asked Questions About What Happens When You Pay an Employee Incorrectly

Who is responsible if an employer makes mistakes with payroll?

Payroll accuracy ultimately falls on the employer. 

Whether the mistake stems from human error, software issues, or miscommunication, the employer is obligated to correct the errors promptly and follow federal and state laws.

If the employee provides inaccurate information—such as incorrect bank details or tax forms—the employer may not be at fault. However, the employer still needs to address the error as soon as it is identified.

What happens if an employer pays you by mistake?

If you have been overpaid, the employer is typically entitled to recover the overpayment. However, they must notify you and comply with state laws when arranging repayment. 

Some states require your written consent before any deductions can be made from future paychecks. Others may require the employer to work out a repayment schedule directly with you.

In most cases, the repayment can be handled through a deduction in your next paycheck or a written agreement for installment payments.

Overpayments can also create tax complications. 

Since the employer has already reported and paid payroll taxes on the incorrect amount, they may need to file adjustments with the IRS and state tax authorities to recover those taxes. 

This process can take time, so prompt communication between employer and employee is important.

If you're asked to repay a gross amount rather than the net amount you received (i.e., before taxes), it's often because the employer needs to recoup the full amount paid and later file for a tax correction.

How long does a company have to fix a payroll mistake?

State laws vary, but employers typically have up to two or three years to recover an overpayment. In some cases, the time limit may align with the state’s general statute of limitations for wage disputes or contract claims.

Some states allow employers to deduct overpayments from future wages without employee approval, while others require written consent before any repayment can be made through payroll. 

A few states, such as Oregon and Washington, require employers to negotiate a repayment plan with the employee instead of making unilateral deductions.

Federal law also plays a role. While the Fair Labor Standards Act (FLSA) allows employers to recover wage overpayments, it prohibits deductions that reduce an employee’s pay below minimum wage unless specific exemptions apply. 

In those cases, employers may need to recover the overpayment over multiple pay periods to maintain compliance.

Am I obligated to pay back an overpayment?

Yes. If you were overpaid, you’re generally required to return the excess amount—even if the mistake wasn’t your fault or you didn’t notice it.

Employers must follow the proper legal process when requesting repayment, which can vary depending on the state. Some states allow deductions from future paychecks as long as the employee is notified, while others require a written agreement or voluntary repayment plan.

In some cases, employers may ask you to repay the gross amount (before taxes) so they can adjust payroll tax filings with the IRS and recover the associated tax liabilities. If the overpayment is substantial and you cannot repay a lump sum, you can often work with your employer to arrange installment payments.

Failing to return an overpayment could result in legal action, especially if the employer can show good faith efforts to recover the funds.

How long does an employer have to reclaim overpayment?

State laws determine how long an employer has to reclaim an overpayment, but in most cases, the window is about two years. Some states tie this timeframe to general wage dispute statutes or contract limitation periods.

In states that require employee consent, the employer must secure written permission before deducting anything from future paychecks. In others, like Oregon and Washington, employers must negotiate a repayment plan rather than make automatic deductions.

Federal law doesn’t set a specific statute of limitations for recovering overpayments but does require employers to comply with the Fair Labor Standards Act (FLSA). 

That means no deductions can reduce an employee’s pay below the federal minimum wage. In such cases, recovery may need to happen gradually over multiple pay periods.