Employer Lending: Exposing Risks and Rewards
Owning, operating, and managing a business in today’s economic and regulatory
environment is more challenging than ever. On top of their normal day-to-day
obligations, busy executives also need to stay on top of ever-changing employment
law.
Of course, anyone overseeing or administering employee benefit plans needs to be
well-versed in federal laws, such as the Employee Retirement Income Security Act
(ERISA) and the ever-changing IRS Codes. However, it doesn’t stop there.
Employers today must also maintain compliance with both state and local
regulations.
One challenge in remaining compliant with these laws is the ability to fully
understand which employment practices and/or benefits are affected by the shifting
sands of laws and regs.
The Price of a Good Deed
There are many rewards for employers who offer employee benefit programs, but
they can pose hidden risks if not managed properly. Even a big-hearted business
owner acting with the best of intentions can find themselves in violation of certain
labor laws and tax codes. This is often the case with employers who loan money to
their employees as an advance against wages.
Ignoring the financial challenges faced by employees also presents a danger in
terms of workplace theft and lost productivity due to ‘presenteeism’ – a condition
where stressed employees are more focused on their personal financial troubles
than on their job. It has been estimated that presenteeism costs employers about
$180 billion per year in productivity losses.
Financial distress also leads to
increased absenteeism, due to its effect
on workers’ physical and mental health.
In fact, money was cited as the largest
source of stress among respondents to
a recent American Psychological
2
Association survey, with nearly three-quarters noting that their stress level has
increased or stayed the same over the past five years.i
Despite the fact that the U.S. economy is continuing to slowly recover, American
families are still burdened with a mountain of debt. As of the first quarter of 2013,
U.S. consumers owed a total of more than $11 trillion in debt. This includes student
loans that have increased 6.1% from 2012, impacting the financial stability of a
large percentage of working families.ii
When faced with unexpected expenses, these families face dire circumstances, and
many employees have no place to turn other than payday loan companies.
According to the Center for Responsible Lending, twelve million Americans are
trapped in a cycle of high-interest payday loans, with the typical borrower taking an
average of nine payday loans per year, often at annual interest rates approaching
400 percent.iii
Obviously, there is a great need for salary advances in today’s economy. So is an
employee loan program really a bad idea? Like a lot of things in business, it
depends on how you go about it.
Devil in the Details
Before considering employee salary advances, employers should be aware that
instituting this type of program in-house can have tax and licensing implications, as
well as creating fiduciary responsibility. A program of this nature can even result in
a lawsuit if there is any hint of discriminatory practices.
Additionally, any employer making loans to employees may be subject to the
stringent disclosure requirements and regulations of consumer lending laws, on
both the federal and state level. And depending on the state in which a company is
doing business, local laws may hinder or actually prevent the collection of
repayment on the debt.
Tax code violations: In a memo issued by the IRS, it was determined that the
doctrine of constructive receipt can apply to employee loans, meaning a salary
advance may be subject to income tax withholding in the earliest open tax year in
which the advance was available.ivHowever, the IRS memo added that if there is no
constructive receipt, the employer loan program
is in violation of Internal Revenue Code IRC
Section 409A. Failure to comply with IRC 409A
means the employee can be charged back taxes
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retroactive to the year of the advance, with interest and penalties, while the
employer is in non-compliance with the tax code.
Taxable interest: It’s not uncommon for an employee to ask for a small advance
on their next paycheck, and many employers wouldn’t hesitate to grant that
request, particularly if the employee is facing hardship. Perhaps the employer
considers it a simple loan that the employee will pay back on payday without
interest. However, the IRS generally expects a lender to recognize interest income
and the employer may be subject to taxes on that income, even if they did not
charge any interest on the loan.
State wage laws: Even the most vigilant and dedicated HR director can be
challenged when keeping current with state and local wage laws, which tend to
frequently shift with the whims of the latest administration. Does your state allow
an employer to deduct loan payments from employees’ paychecks? Not sure?
In New York, employer lending regulations include provisions governing the timing,
frequency, duration and method of loan repayment; limitations on the periodic
amount of repayment; and the establishment of procedures for disputing or
delaying repayment, which must be provided to the employee in writing before the
loan is made.
This is an example… Failure to fully understand constantly changing state wage
laws can easily result in a violation.
What If…?
Without a documented lending procedure, misunderstandings can easily occur.
What if the employee requests an advance against future commissions that are
never earned? Is there a procedure in place to ensure that the advance is repaid?
And even with a documented procedure, what happens if the employee quits before
the full loan amount is reimbursed? If the company is doing business in California,
the employer may be out of luck. Although the California Labor Law does allow for
paycheck deductions to repay an employee loan, it is illegal for the employer to
take the full lump sum payment for an outstanding balance out of one paycheck. If
the employment relationship ends before the loan is paid off, the employer can only
deduct the amount of one installment payment from the employee’s final paycheck.
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Safe, Not Sorry
There are many good reasons to offer financial aid for your workforce, helping
employees stay happy, focused and financially fit. And it has been demonstrated
that a financial benefit program can help reduce negative physical effects of stress
on workers’ health, helping to alleviate absenteeism and the occurrence of
presenteeism for a more productive workplace.v
However, creating an employer lending program in-house without a full
understanding of all the potential issues can result in a multitude of liabilities for
employers, not to mention a lot of red tape and paperwork.
Fortunately, there are reputable resources for third-party employee lending
programs, such as the Employee Benefit Loan Program from FinFit. Contracting with
an expert that offers affordable, legal employee loans that are not discriminatory
can protect your company from serious legal liability and tax implications.
The FinFit Employee Benefit Loan Program is an
integrated part of an overall financial wellness service,
offering educational resources, identity theft protection,
debt management and budget calculators, in addition to
quick and convenient loans, at no cost to employers.
Employees enrolled in the FinFit program have access to
a loan or line of credit without regard to credit scores,
with a quick and convenient application process and a
direct payroll deduction service that makes repayment
easy. FinFit employee loans are available at substantially
lower costs than other short-term financial solutions,
providing a viable alternative to predatory payday loan
companies and early withdrawals from 401K accounts.
Contact FinFit to learn how you and your employees can reap the rewards of a
third-party Employee Benefit Loan Program while avoiding the risks inherent in
employer lending.
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i
American Psychological Association. “Stress in America™: Missing the Health Care
Connection”, Released February 7, 2013:
http://www.apa.org/news/press/releases/stress/2012/full-report.pdf
ii
Federal Reserve Bank of New York. “Quarterly Report on Household Debt and Credit”,
2013 Q1:
http://www.newyorkfed.org/research/national_economy/householdcredit/DistrictReport_Q1
2013.pdf
iii
Center for Responsible Lending. “Fast Facts – Payday Loans”:
http://www.responsiblelending.org/payday-lending/tools-resources/fast-facts.html
iv
v
Internal Revenue Service. Memo 200935029: http://www.irs.gov/pub/irs-wd/0935029.pdf
Partnership for Workplace Mental Health. “Employee Personal Financial Distress and
How Employers Can Help”, February 2009:
http://www.workplacementalhealth.org/Publications-Surveys/Research-Works/EmployeePersonal-Financial-Distress-and-How-Employers-Can-Help.aspx