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Payment of Wages: Federal

Payment of Wages requirements by state

Original Author: Ryan F. Donovan

Updating Author: XpertHR Editorial Team

Summary

  • Employers must comply with both federal and state law when paying employees. The Fair Labor Standards Act (FLSA) only generally requires that employees be paid by their regular payday. The vast majority of the wage payment laws and regulations are at the state level and they are more specific than the FLSA. See General Considerations.
  • Employees may be paid in cash or its equivalent, such as a check, by direct deposit, or with electronic paycards. Many variables must be considered when deciding which method to use to pay employees. See General Considerations.
  • If paying by cash or check, states generally require that employees be able to cash their paychecks for face value without charge or discount at a financial institution that is close to where they work or live. Because of inherent risks of paying employees by cash or check, employers should take certain precautions if using this wage payment method. See Payment by Cash or Check.
  • Direct deposit allows employers to deposit employees' pay directly into bank accounts designated by the employees without using a physical paycheck. Paying employees via direct deposit eliminates many of the problems associated with paying by cash or check. Direct deposit is regulated by both federal and state law. See Payment by Direct Deposit.
  • Electronic paycards are an alternative wage payment option for employees who do not have, or cannot obtain, a bank account that can receive direct deposits. As many as one in 10 employees cannot be paid via direct deposit. Paycards are regulated by federal laws that are similar to the direct deposit laws, as well as by state laws. See Payment by Electronic Paycard.
  • HR and payroll departments need to know ahead of time whether there will be an extra pay period caused by the calendar in any given year. If not planned for and handled properly, an extra pay period can cause an unanticipated increase in wage expenses that was not accounted for. See Extra Pay Periods Caused by the Calendar.
  • After the death of an employee, employers must follow a specific set of rules in order to properly turn over any compensation owed to the deceased employee's estate or survivors. See Deceased Employee Wages.

General Considerations

Although paying wages is one of the more basic functions that all employers of all sizes must engage in, many variables must be considered when determining which method to use to pay employees. First, employers must comply with both federal and state laws in this area. A basic rule of thumb is that anything not regulated by federal law is left to the states. In addition, for any area regulated by both federal and state law, the law that is more favorable or protective of employees is the one that employers must follow.

The basic federal law related to wage payments, the Fair Labor Standards Act (FLSA), only generally requires that employees must be paid by their regular payday. Federal courts have held employers in violation of the FLSA for paying employees later than payday. In addition, there are federal regulations that prohibit employers from changing pay frequencies to avoid paying overtime pay (but they may change pay frequencies if the change is permanent and made for a legitimate business reason) +29 C.F.R. §§ 778.301; +29 C.F.R. §§ 778.302.

The vast majority of the wage payment laws and regulations that employers must comply with, however, are at the state level and they are more specific than the FLSA. Most states have laws governing:

  • Methods of wage payment;
  • Pay frequency;
  • Lag time (how soon after payday employees must be paid);
  • Permitted and prohibited pay deductions;
  • Termination pay requirements;
  • Pay statement/paystub requirements;
  • Deceased employee wages requirements; and
  • Unclaimed wages requirements.

A few states also require employers to distribute pay-related notices to employees.

See State Requirements; Pay Frequency and Lag Time Requirements by State; Permitted and Prohibited Pay Deductions by State; Final Wage Payment Requirements by State.

Once the applicable laws are identified, an employer can decide on the wage payment method(s) it will use. Because federal law is generally silent regarding the methods or means an employer may use to pay employees, most state laws permit employers to pay wages with either cash or its equivalent, such as a check. See Payment by Cash or Check; State Requirements. Employers may also pay wages using direct deposit to savings or checking accounts or using electronic paycards. See Payment by Direct Deposit; Payment by Electronic Paycard. These two methods are governed by both federal and state law.

The reasons employers or employees choose one wage payment method over another can range from personal preference to necessity. A person who lives, works and banks in the same city will not be unduly burdened if a check has to be cashed every pay period. On the other hand, employees who travel a lot or are geographically dispersed and/or separated from the party handing out checks would probably opt for an electronic method of payment.

Practical Example

A small branch of Acme Credit Union has five employees. It offers wage payment via check, paycard or direct deposit. It does not require direct deposit as a condition of employment.

  • Robert is 17 years old. Since he is a minor, paying him by direct deposit or paycard is not the best option because his parents must co-sign. If they do not, Robert cannot be held liable under the terms of the paycard contract. Paying him by check is certainly acceptable.
  • Alexis is unable to get a bank account because she has bad credit. Therefore, she cannot be paid via direct deposit. However, if she does not want to be paid by paper check, a paycard would be a viable alternative.
  • Eric has a bank account and wants to sign up for direct deposit. He can do so provided he authorizes this method of payment and Acme follows all federal (and any applicable state) rules in administering the program.
  • Duane wants to be paid by paper check. Before honoring his request, Acme should caution him that mailed checks can be lost or stolen, he may face a delay in cashing a check if banks are closed, or, if he normally picks up his checks at work, there may be occasions when he may not be able to get it in hand on payday should bad weather prevent him from getting to work or should he be out sick, etc. Direct deposit and paycards are largely immune from these types of potential setbacks that can affect employees who receive a live check.
  • Amelia insists on being paid in cash. Acme is not required to pay any employee using cash since it offers its employees a number of different options that do not unfairly or illegally restrict their choices. Acme management should explain to Amelia that there are strong reasons not to pay with cash, such as greater likelihood of theft. Receiving the entire net amount of a check all at once is unwise because having a wallet lost or stolen when the rent or a car payment is due can be a personal disaster. Consumer protections for electronic money mediums are much more expansive.

Due to Acme Credit Union's small size, direct deposit may not be the most cost-effective option. However, it is almost certainly the option with the least amount of potential problems.

Payment by Cash or Check

Two of the more traditional methods of paying wages, yet becoming less common as time goes on, are cash and check. Check types can include personal or business checks, checks produced in-house, or checks processed by a regional or national third party payroll provider. The laws of all the states and the District of Columbia either explicitly allow employers to pay with cash or check or they do not have a provision governing the method of payment at all. As a general rule though, states require that employees be able to cash their paychecks for face value without charge or discount at a financial institution that is conveniently close to where the employee works or lives. See State Requirements.

Paying wages in cash becomes a problem if a disagreement arises between how much the employer and the employee say has been paid. Use of paper trail items, such as receipts and paystubs, is highly encouraged and is often mandated by state law, regardless of how the wages are actually being paid. See State Requirements. Should a dispute arise, paying employees via checks, direct deposit or paycards will make the reconciliation and resolution processes easier. Employers also should be aware that wages are not technically paid until they are actually, or constructively, received by the employee. That is, when the employee has immediate and unrestricted use of the funds.

Employer Precautions

The following are precautions to take when an employee asks to be paid in cash or by check:

  • Avoid paying in cash if possible. Lack of a paper trail and wage disputes where either or both parties cannot prove precisely what was paid can lead to a legal entanglement or some other tense situation.
  • Understand that wages are not considered paid until they are constructively received by the employee. If the employee does not have the funds in hand and/or does not have unrestricted access to them and payday has arrived or passed, the employer company can be fined for failure to pay wages when they were due. Employers must act in good faith and be as proactive as possible.
  • Give employees paystubs that show a breakdown of what has been paid and for what period, the path from gross pay to net pay, and a year-to-date statement that shows all wages paid, deductions made, and taxes withheld up to that point in the year. These are often required by state law anyway. See State Requirements.

Payment by Direct Deposit

Direct deposit is the most popular way to pay wages due to its many inherent advantages that make it a much more attractive option than paying wages via cash or check. Many employees have come to expect direct deposit to be a payment option. It allows employers to deposit employees' pay directly into bank accounts designated by the employees without using a physical paycheck. Several common annoyances and problems associated with paying by cash or check largely disappear when employees are paid via direct deposit, such as:

  • Lost or stolen cash or checks;
  • Unclaimed or uncashed checks;
  • Employees needing to get to the bank during normal work hours or breaks;
  • Checks requiring storage before or after payment of wages; and
  • Checks for vacation and paid time off requiring advance disbursement.

Direct deposit is not entirely paperless and overall costs may actually increase if the number of employees using it is small. The reason is that there is a certain amount of overhead that vendors must bear in order to offer the service to any given customer, which puts a floor on the price that must be charged. This floor price can be high if only a few employees use the service and the employer is being charged the same amount as an employer with hundreds or thousands of users that can better distribute the cost. In addition, some states require a paper voucher and written direct deposit authorizations which must be kept on file and stored. The only exception typically offered, if at all, is that the employee can waive the paper voucher and opt for an electronic one, but the employee cannot be coerced into doing so. See State Requirements.

How Direct Deposit Works

Direct deposit is a process whereby the net pay due an employee for a pay period is disbursed electronically into an employee's bank account via a method known as Automated Clearing House (ACH). The ACH process was created and is regulated by the National Automated Clearinghouse Association (NACHA). For every direct deposit disbursed, there is an Originating Depository Financial Institution and a Receiving Depository Financial Institution (RDFI). The direct deposit function is tied to the employee's savings or checking account.

Checking and savings accounts that are able to receive direct deposits have two relevant strings of numbers that are necessary to properly set up a direct deposit for an employee. The first number is the ABA number. This number is often referred to as the routing and/or transit number. The first four digits of this nine digit number is the routing number. The fifth through eighth digits are the transit number. The ninth number is a check digit to ensure the ABA number as a whole is valid. The ABA number indicates the bank where the employee has his or her account, or the RDFI. The account number is specific to the employee. The length of the routing/transit number never varies but the length of a bank account number can vary greatly.

When setting up a direct deposit for an employee, the relevant numbers must be keyed in exactly as they appear on the check. Additionally, the routing/transit number on the employee's check should be used as opposed to the number on the deposit slips. The routing/transit number on deposit slips can be a different, and incorrect, ABA number and not what is needed for a direct deposit, even for the same account.

Federal/State Relationship

Direct deposit is regulated by both federal and state law. The federal law that applies is Title IX of the Consumer Credit Protection Act, also known as the Electronic Funds Transfer Act (EFTA). Pub. Law No. 95-630; 15 U.S.C. § 1693a-1693r. This set of regulations is explained and implemented by Federal Reserve Board Regulation E and Staff Interpretations under the EFTA. The federal rules permit employers to require employees to use direct deposit as a condition of employment only if the employees can choose from a list of financial institutions. The employer also can require direct deposit at a certain financial institution provided it also gives the option of payment by cash or check. Employers cannot require direct deposit at a certain financial institution without providing other payment alternatives. +15 U.S.C. § 1693(k); +12 C.F.R. § 205.10(e)(2); Supplement I to +12 C.F.R. § 205.10(e)(2).

International Payments. An updated set of operating rules issued by NACHA on September 18, 2009, include regulations on how to handle International ACH Transactions (IATs). These changes were crafted based on the requirements issued by the Office of Foreign Assets Control, which is a division of the United States Treasury Department. The purpose of the IAT regulations is to prevent international financial transactions that may fund criminal activities.

Under the rules, employee payments disbursed by employers in the United States to a foreign country must be coded in a certain way. In addition, the permanent address of the payer and the payee must be included in the ACH header of the international transaction. Failure to include the required information can lead to international payments being blocked by financial institutions and fines being levied against the employee and employer. Employers must perform their own due diligence to ensure they are complying with these standards if they have employees who are forwarding money overseas.

To avoid potential liability, employers must act in good faith and follow the regulations to the letter. The regulations apply to any international payments, including direct deposit of pay, benefits, pensions, and third party payments, such as child support.

Employee Authorization Requirement

An employer may not begin direct deposit of an employee's wages without first obtaining the employee's authorization. The employee must provide the employer with three pieces of information:

  1. The name of the employee's bank and the bank's routing/transit number;
  2. The type of bank account the funds will go into (savings or checking); and
  3. The employee's account number.

The employee's direct deposit authorization may be made orally, in writing, or electronically. Employers should be cautious when relying on oral authorizations because there will be no official written record that the employee has authorized the direct deposit. In addition, if there is a mistake, there is usually no way to clearly establish whether the mistake was made by the employee or the employer. Some mistakes can be quite costly. For example, the wrong employee may receive the funds in error and may immediately withdraw the money and the direct deposit reversal will fail. If it cannot be proven that the employee made a mistake in his or her authorization, the employer would be left to take a loss or pursue the person who has the funds. See also Direct Deposit Program Letter, which an employer may use to notify employees about its direct deposit program.

NACHA guidelines provide that single payments made to individuals in error, either because the amount was incorrect or the individual was not owed any money to begin with, can typically be reversed within five banking days after the payday. Some state laws, however, provide that reversal of a direct deposit cannot be made without explicit authorization of the employee. Thus, employers must check the law of the state involved. As a best practice, employers should go over the form with the employee and make sure he or she checks the form a second time to ensure there are no inaccuracies. Even though it adds a step to the process, it is wise to require a voided check and compare the account and ABA numbers between the authorization data and the voided check to ensure that they match.

Prenotification Option

Prenotification, or prenote, is a way to test whether a direct deposit account is fully authorized for use. It allows the receiving bank to verify whether the information for the direct deposit provided by the employee is accurate by sending a deposit for zero dollars. If payroll enters an incorrect number, the receiving bank or credit union will provide feedback as to the nature of the error. An error may occur due to an invalid account number, a designated account may have been closed, a designated account may be frozen due to identity theft, or the wrong account type may have been indicated. In the latter case, the receiving bank may accept the payment even though it issued a warning code, but it is not required to do so and may eventually delete the direct deposit setup.

Prenotification is not required by law. If it is used, the transmittal should be sent at least six days before the employee's actual pay will move through the system. If the prenotification fails, the employer will be notified and must tell the employee that there is a problem and that he or she must verify or correct the numbers provided.

The following are key points employers must keep in mind when enrolling an employee in direct deposit:

  • The minimum information required is the name and routing number of the financial institution, the type of account (checking or savings), and the employee's account number.
  • Obtain a direct deposit authorization prior to disbursing the employee's funds for the first time. Doing this in writing is not required but is highly recommended. If done in writing, the employer should have the employee sign off on the accuracy of the data on the form. This will usually relieve the employer of fault for any inaccuracy as long as the person keying the information with the bank does so correctly. If written authorization is used, retain the form for two years after the direct deposit authorization is revoked, not from when it was initiated.
  • Use the direct deposit prenotification process whenever practical and possible. If it is not possible to use prenote, check all information at least twice to ensure it is accurate.
  • After the direct deposit is successfully set up, take great care to ensure the employee's pay is accurate on every run. Federal provisions allow direct deposit reversals within five business days, but the reversal may be restricted or disallowed under state law and/or the reversal may fail due to insufficient funds.

Payment by Electronic Paycard

Paycards are another way to pay employees using electronic means. They are a good option for people who do not, or cannot, have a bank account that is capable of receiving direct deposits. Approximately one in 10 employees is unable to use direct deposit as a means of wage payment.

See Pay Employees Using Paycards, for a variety of tools that will help an employer pay employees using paycards.

How Paycards Work

Paycards operate in a way that is very similar to debit cards and direct deposit, except that the employee need not have a bank account in order to be paid wages using this method. Instead, money is loaded onto the paycard itself, much like a gift card, and the employee can then use the card as a debit card.

Types of Paycards

Because paycards are a relatively new payroll option, there is not much historical data that demonstrates whether one kind of paycard is better than another. There are two major types of paycards: branded and nonbranded.

Branded Paycards. Branded paycards bear the stamp of Visa, MasterCard, or Discover. They are accepted wherever Visa, MasterCard and Discover cards are accepted and they operate as debit cards. The owner of a branded paycard is typically issued a four digit personal identification number (PIN), which may be used to make debit point of sale (POS) purchases, withdrawals at automated teller machines (ATMs), and to check the available balance. Card owners may also simply provide their signature for certain transactions rather than using their PIN. These cards are a popular option because they are so widely accepted and easy to use.

There are some downsides for employers, however, to offering branded paycards. Because branded paycards are personalized to the employee, it can easily take a week or more for an employee to get their first paycard. In addition, the initial process must be repeated if the card is ever damaged, lost or stolen.

Nonbranded Paycards. Nonbranded paycards are linked to ATM or POS networks, such as STAR, Pulse and NYCE. They differ from branded paycards in that, when used for POS transactions, the card owner must key in a PIN every time. Simply swiping and signing for a transaction cannot be done with a nonbranded card. Withdrawals and balance checks at ATM's can also be executed with a nonbranded card by entering a PIN. In short, the PIN must be used and entered correctly every single time the card is used regardless of the type of transaction.

Transactions using nonbranded cards also differ from branded paycard transactions in that a host computer must approve the transaction or verify that there is enough money in the account. With branded cards, even if the system is down, payment is sometimes authorized up to a certain amount or in certain other circumstances. This can happen even if it cannot be firmly established that enough funds exist in the account. If the computer system for a nonbranded card is down, the transaction will typically fail.

Employers should consider the following things when deciding what kind of paycards to offer employees:

  • Employees' age. Paycards often require employees to enter into a contract first, and minors cannot be held liable under contracts unless their parents have agreed, in writing, to accept any liability for the minor's use of the card.
  • Employee turnover. Issuing and replacing branded cards is a lot more involved and labor intensive than it is for a nonbranded card. This is because branded cards are personalized to the employee whereas nonbranded cards are not. Employers, however, are permitted to use a mix of branded and nonbranded paycards and to distribute them based on the tenure, or projected tenure, of an employee.

Paycard Advantages. The following are some advantages to paying employees with paycards:

  • Lowered costs associated with manual, stolen and lost checks;
  • Reduced stop-payment fees because of less use of paper checks;
  • Fewer concerns about what to do with unclaimed or uncashed checks;
  • Increased productivity since employees do not need to leave work to go cash a check;
  • Employees with no bank account are not excluded from eligibility; and
  • Records are electronic, which makes them much easier to manage, track and store.

The following are some advantages for employees paid with a paycard:

  • No check cashing fees;
  • Reduced need to get help from family or friends to pay bills or cash checks because there are fewer limitations on availability of funds with 24/7 ATM access;
  • Ease of use;
  • Protection if the card is lost or stolen (they can be replaced at full value); and
  • Full amount of paycheck does not have to be handled all at once unless desired.

State Paycard Regulations

Federal paycard laws and regulations generally mirror direct deposit laws. But because the paycard movement is still relatively new, the state laws that pertain to them vary widely from state to state and have been emerging very slowly. More than half of the states have passed laws that govern paycards in some way. Employers must comply with all applicable federal and state laws pertaining to paycards. Depending on the state, a number of restrictions or guidelines may apply. See State Requirements.

The following are examples of what the state paycard rules and regulations provide:

  • Restrictions or prohibitions on fees that can be imposed on employees for using the card or withdrawing funds (in many states, funds must be available with little or no restrictions);
  • The requirement to provide employees with full written disclosure of their rights and responsibilities regarding possession or use of the card in easy to understand language;
  • The prohibition that employers may not require the use of a paycard for some or all of their employees under certain circumstances; and
  • The requirement that state employees must participate in a paycard program.

Federal Reserve Board Regulation E

The Federal Reserve Board (FRB) issued a final rule on paycards in 2006 under Regulation E, which implements the Electronic Funds Transfer Act. It took effect on July 1, 2007. The final rule defines a paycard account in the same way as Regulation E. Thus, a paycard account must meet the same legal requirements as a conventional direct deposit account held by an employer. Pooled paycards in which multiple accounts are grouped together are also subject to this set of rules.

There are a few other applicable rules that employers need to comply with. First, not all paycards and their offshoots are covered under Regulation E. A distinct example of something that is not covered is a paycard tied to a health care account, such as a flexible spending account. Also, a dual use account that consists of a personal portion and a corporate portion is not entirely subject to Regulation E. Any portion that is personal and familial in nature is subject to Regulation E, but the corporate part of the account is not. Last, except in very limited circumstances, employers are not considered financial institutions under Regulation E if a paycard system is in effect.

Employers are also allowed to provide nonactivated paycards to employees when offering or presenting a paycard program to them. However, the employee cannot be required to use the card and must be given the choice to be paid via other means. Employers may not require the use of a particular paycard, just as they cannot require employees to use a particular bank for direct deposit. Use of a paycard must be offered as one of several options for wage payment that employees can choose from. Full disclosure of the terms and conditions of a paycard program must be made available to employees as well as pay statements at predetermined intervals or on demand. +12 C.F.R. § 205.2(b)(2), +12 C.F.R. § 205.18, +71 Fed. Reg. 51440, +71 Fed. Reg. 1475.

Final CFPB Paycard Regulations

The Consumer Financial Protection Bureau (CFPB), which took over jurisdiction for Regulation E from the Federal Reserve, issued final regulations, effective April 1, 2019. The final regulations update and clarify certain aspects of paycards under Regulations E and Z. Regulation Z covers the advancement of credit (e.g., overdraft protection) on employer-provided paycards.

Although these final regulations focus primarily on financial institutions, they impact employers that deal with financial institutions to implement a paycard program. The final regulations encompass all prior regulations and impose new employer requirements.

Covered Paycard Accounts

The final regulations only pertain to paycard accounts into which employees' wages are periodically deposited. These particular regulations do not pertain to:

  • Paycard accounts used only in isolated instances, such as to provide funds to employees in an emergency;
  • Accounts used solely to disburse incentive-based payments (other than commissions), which are unlikely to be an employee's primary source of compensation;
  • Other payments that are unrelated to compensation, such as petty cash reimbursements or travel per diems; or
  • Accounts loaded only with funds from a health savings account, flexible spending arrangement, medical savings account, health reimbursement arrangement, dependent care assistance program or transit or parking reimbursement arrangement.

These payments may be subject to other aspects of Regulation E, however.

Transparency and Disclosure

The final regulations require financial institutions to provide various disclosures to employees who have a new paycard account prior to the first time pay is loaded onto a paycard. Employers should ensure that newly hired employees receive and understand these disclosures.

Short-form disclosures. Short-form disclosures have a specific format and contain the following information:

  • A statement that the employee does not have to accept wages on a paycard and that he or she should ask about other wage payment methods. As an alternative, the statement may indicate that the employee has several payment options, followed by a list of those options, and a statement directing the employee to inform the employer about which option he or she is choosing;
  • A list of static fees, even if they are $0 or relate to features not offered by the employer's paycard program, including periodic fees, per-purchase fees, ATM-withdrawal fees, cash-reload fees, ATM balance-inquiry fees, customer-service fees and inactivity fees;
  • The number of fee-types the employee may be charged under the specific paycard program; and
  • Statements regarding linked overdraft credit features, registration, government insurance (i.e., FDIC/NCUA insurance) and the CFPB's website, where the employee can obtain general information about prepaid accounts and where to find the long-form disclosure.

States may also require the same or more disclosures, and employers must ensure employees receive them.

The regulations also require, in addition to and in close proximity to the short-form disclosure, that a financial institution disclose its name, the name of the paycard program, the purchase price and any activation fee.

Long-form disclosures. The long-form disclosure, which includes comprehensive fee information as well as certain other key information about the paycard account, must also include the following information:

  • A title, including the name of the paycard program;
  • Information about any fees and conditions;
  • A statement regarding registration and FDIC/NCUA insurance;
  • A statement regarding linked overdraft credit features;
  • The financial institution's contact information;
  • A statement directing the employee to the CFPB website for general information about prepaid accounts; and
  • A statement as to how employees can submit a complaint to the CFPB regarding a paycard account.

Financial institutions must provide the disclosures electronically for paycards acquired by employees online or through a mobile device, but employee consent is not required prior to sending them electronically.

Written pre-acquisition disclosures. If a financial institution provides the disclosures in writing before an employee acquires a paycard, the disclosures do not have to be provided again electronically or orally. If, for example, an employer distributes printed copies of the disclosures to a new employee with instructions to complete the process online if the employee wants to be paid via a payroll card account, the financial institution is not required to provide the disclosures electronically because the employee has already received them.

Foreign language pre-acquisition disclosures. A financial institution is not required to provide pre-acquisition disclosures in foreign languages if the employer accommodates employees who do not speak English by providing a real-time language interpretation service the employees can access by telephone.

Change in terms or conditions disclosures. The final regulations also require financial institutions to provide employees with a notice when any paycard terms or conditions change, and to disclose their name, website and telephone number on paycards. Or, if there is no physical paycard, these disclosures must be made on a website, mobile application or other entry point that employees must visit to access their paycard accounts.

Consumer Protections

The final regulations enhance already existing protections for employees by increasing the time period for account transactions histories to 12 months, requiring periodic statements and account transaction histories to disclose the total fees assessed against the account and display a summary total of the amount of fees that are assessed against the account for the prior calendar month and for the calendar year to date.

Hybrid Prepaid Credit Cards

The regulations add the term hybrid-prepaid credit card to Regulation Z and specify the requirements that apply to such cards. These are paycards that have credit features, such as overdraft protection. State laws, however, may ban paycards that have credit features attached.

The final regulations require certain explanatory material to be provided for such cards, and they amend Regulations E and Z to regulate overdraft credit features offered in connection with paycards.

A paycard is a hybrid-prepaid credit card subject to Regulation Z if the following circumstances apply:

  • The card has a separate credit feature, so that the employee can use it to access credit from a credit account or credit subaccount that is separate from the paycard's asset feature;
  • The separate credit feature is offered by the paycard issuer, its affiliate or its business partner; and
  • The employee can use the paycard to access the separate credit feature in the course of authorizing, settling or otherwise completing transactions conducted with the card to obtain goods, services or cash, or to conduct person-to-person transfers.

A paycard, is also a hybrid-prepaid credit card if it is a single device that can be used from time-to-time to access credit through a negative balance (i.e., overdraft protection) on the prepaid account's asset feature, unless certain additional circumstances apply.

Choosing a Paycard Vendor

Employers should consider all of the following when choosing a paycard vendor:

  • Fees. There are always costs involved in administering a paycard program and they have two major implications. First, before deciding on a paycard vendor, ensure that the program the vendor is offering is cost-effective for the employer and that it will not impose burdensome costs on employees. Second, ensure that the fee structure for the employer and the employees complies with any applicable state laws. The paycard vendor should know its legal obligations, but employers should be proactive by verifying on their own what the applicable laws permit.
  • System compatibility. Ensure compatibility between the paycard system and the employer's existing HR/payroll system infrastructure from both a software/hardware standpoint and a systemic/procedural standpoint. Conduct a thorough cost-benefit analysis before moving forward to determine what effect adding a paycard option will have on the amount of time and effort required to make wage payments.
  • Vendor support. Determine what kind of service and support the vendor offers and get the details in writing rather than relying on oral representations. Search the Internet for reviews of the vendor and ask to speak to clients that use the service to find out their level of satisfaction.

Implementing a Paycard Program

Once a paycard program has been selected, employers should take the following steps to implement the program:

  • Communicate the change to all levels of management that are not already aware of the impending implementation.
  • Assemble a team to help internally implement the system. This group should be comprised of employees from all affected departments. Seek the help of the paycard vendor, too, whenever possible.
  • Train employees on how to enroll in the program, how to maintain their setup, how the program works from their perspective, and the benefits of using the program.
  • When enrolling employees, collect all necessary information from them including name, address, phone number, social security number and mother's maiden name.
  • Train certain employees to become experts on the system so they can handle employee queries and problems when they arise.

See How to Implement a Paycard Program.

Extra Pay Periods Caused by the Calendar

HR and payroll departments need to determine ahead of time whether there will be an extra pay period caused by the calendar in any given year. If not planned for and handled properly, an extra pay period can cause an unanticipated increase in wage expenses that was not accounted for. See How to Handle Extra Pay Periods Caused by the Calendar.

Practical Example

In every calendar year of 365 days at least one day of the week occurs 53 times: 52 weeks x 7 days/week = 364 days. In leap years, which have 366 days, two days of the week will occur 53 times. In 2011, there were 53 Saturdays. In 2012, a leap year, Sunday and Monday both occured 53 times. In 2013, Tuesday occured 53 times. The potential impact to an employer depends largely on the pay frequency used and whether employees on the payroll are exempt or nonexempt.

Weekly and Biweekly Payers

Other than holidays or other factors that can shift a payday, weekly and bi-weekly runs always pay on the same day of the week. If the processing schedule is weekly and the selected day of the week is the day that happens to occur 53 times, an extra payday will have to be accounted for. If the employer pays biweekly, whether the extra payday occurs will depend on when the paydays fall in late December and early January. If there are only 26 runs each in the year ending and the year that will begin, then there is no cause for concern. However, if one of the two years has 27 paydays, how the pay is handled for that year with the extra run may need to be adjusted.

Semimonthly Payers

Semimonthly payers have a different set of variables. They typically pay on the same two days of the month, every month. A common semimonthly setup is to pay on the 15th and last day of every month. If it were possible and practical to pay employees on the same two days of the month for all months, the extra payday scenario would never be an issue. However, semimonthly paydays often have to be pushed forward or backward when the normal payday falls on a holiday or weekend.

If a semimonthly payer pays on the 15th and last day of the month and December 31st falls on a Saturday, the employer must make a decision. Because direct deposits are typically not posted on weekends or holidays and checks distributed early may end up not being honored by the employees' banks or may lead the bank to fine the account holder, the payroll department should proceed carefully and proactively. The wise thing to do in this situation is to push the payday back rather than forward, for two main reasons.

First, a shift forward results in 23 total paydays in the year that is ending and 25 in the year that is beginning, assuming the same thing does not happen again in the subsequent year. This can lead employees to think they were paid less than they should have been. Second, it also extends the time window from period end to payday. While this is not a concern under federal law, it may very well be against the law to do this in some states. Remember that New Year's Day (January 1) is a federal banking holiday and should not be used as a payday for employees paid with paycards or direct deposit because the deposits will probably not post until the next business day. When a payday is pushed back employees usually do not complain about receiving their money a little sooner, it is next to impossible for such an arrangement to be against the law, and any concern about a year having a different number of paydays is resolved.

One caveat about pushing a payday back is that direct deposit information must be transmitted by the originating bank no later than three full business days (72 hours) before payday. Direct deposits are not guaranteed to post to employees' accounts if this required window is not met. For example, if payday is normally on a Friday, processing of the direct deposit file would normally have to occur on Tuesday assuming no holidays occur between the transmittal date and payday. If payday is pushed back to Thursday, the transmittal date must also be pushed back a day to ensure timely direct deposits. Note that weekends and holidays are not days that count towards the 72-hour window. The determining factors are the actual time and dates of the transmittal as well as the size and policies of the receiving financial institution. The receiving financial institutions are not legally required to post the deposits if the transmittal is late but they often do so as a courtesy.

Exempt Employees

If there will be an extra payday in a year and there are exempt employees on the payroll, the salary of exempt employees' pay can be reduced to reflect 53 equal installments rather than 52.

Practical Example

A biweekly exempt employee who is paid $40,000 a year would typically be paid approximately $1,538.46 per payroll assuming 26 paydays in the year. However, if an extra payday occurs because the day of the payday (e.g., Thursday) occurs 53 times in the year, the employee's pay could be reduced to $1,481.48 per run. The employee would still make his or her expected salary, and the employer will not overpay the employee.

Nonexempt Employees

Employers must use extreme caution when adjusting salaries for nonexempt employees. The pay structure of nonexempt employees can be based on a number of things such as commission, piecework, hours worked, and so forth. Nonexempt employees can even be paid a flat salary from payroll to payroll so long as they stay under 40 hours in the workweek. However, it is absolutely improper to reduce earnings for verifiably completed piecework, hours worked, overtime, or any other pay item that is linked to work performed or hours worked. Hourly employees must be paid consistent with the hours worked within the workweek. How the payday happens to fall on the calendar is not relevant and should in no way affect the employee's pay.

The following are some tips for handling an extra payday that occurs in a calendar year:

  • Assess the mix of exempt and nonexempt employees.
  • Decide before the year even begins what adjustments will or will not be made because of the extra payday.
  • Do not make midyear adjustments on the fly as the year goes on.
  • Never treat similarly classified employees differently when making adjustments.

Deceased Employee Wages

After the death of an employee, an employer is required to follow a specific set of rules in order to properly turn over any compensation owed to the deceased employee's estate or survivors. These requirements are contained in the state wage payment and estate laws.

Most states regulate the amount of a deceased employee's wages that an employer can pay out before the employee's estate is administered, who the wages can be paid to (e.g., surviving spouse, legal representative, next of kin) and any conditions that must be met before an employer can pay over the wages. While some states have rules for withholding state income tax from a deceased employee's wages, most states follow the federal income tax withholding rules (outlined below) for state income tax withholding purposes.

See State Requirements.

Federal income and employment tax (Social Security/Medicare - FICA, and unemployment insurance - FUTA) withholding from, and reporting on, amounts paid to a deceased employee depends on when the employee died and when the employer made the payment(s). The following three basic rules apply:

  1. If an employee dies after receiving a paycheck (from which taxes were withheld) but before cashing it, the employer must reissue the check/payment in the same amount to the employee's legal representative and report the wages paid and amounts withheld on the deceased employee's Form W-2, Wage and Tax Statement. Before reissuing the payment, the employer should consult state law regarding who is entitled to receive the payment and how much can be paid.
  2. If wages are paid to a deceased employee's estate or legal representative after the employee dies and in the year of death, the employer should not withhold federal income tax from the wages, but it should withhold FICA taxes. The wages are also subject to FUTA tax. The employer should report the FICA taxable wages and the amounts withheld on the deceased employee's Form W-2 in Boxes 3-6. In addition, the amount of taxable income should be reported on a Form 1099-MISC, Miscellaneous Income, in Box 3 (Other), issued in the name of the beneficiary who received the payment.
  3. If any wages are paid to the deceased employee's estate or legal representative after the year of the employee's death, the employer should not withhold federal income or FICA taxes, and should exclude the wages for FUTA tax purposes. The employer should report the wages on a Form 1099-MISC, in Box 3 (Other), issued in the name of the beneficiary who received the payment.

+I.R.C. § 691(a)(1), +I.R.C. § 3121(a)(14), +I.R.C. § 3306(b)(15); +Rev. Rul. 86-109, 1986 IRB LEXIS 109; +Rev. Rul. 71-525, 1971 IRB LEXIS 261; IRS Form W-2, Wage and Tax Statement, and Form W-3, Transmittal of Wage and Tax Statements, and General Instructions.

Future Developments

There are no developments to report at this time. Continue to check XpertHR regularly for the latest information on this and other topics.

Additional Resources

National Automated Clearinghouse Association (NACHA)

Employee Direct Deposit Authorization Letter and Agreement