Early access to wages may require new employment tax analyses

Editor: Greg A. Fairbanks, J.D., LL.M.

Employees desiring access to their wages before their payday via early payment programs and arrangements have left employers wondering whether they need to change their employment tax practices. Employers may not be required to change anything today, but Treasury has taken note and suggested law changes to adapt with the times.

The payroll industry has seen a shift from employees’ receiving wages on a fixed pay schedule to having flexibility via “advance pay” and “on-demand” options for early access to their earned wages through banks, payroll providers, and employers themselves. This item briefly summarizes how these early-access options generally operate (although they are rapidly evolving), how employment tax laws might apply, and Treasury’s proposal to address ambiguity concerning the tax impact of these types of programs.

Advance pay and on-demand pay arrangement options

Advance pay (AP) programs are generally provided by financial institutions (e.g., banks and credit unions) that credit the account holder’s account in an amount equal to the account holder’s paycheck, two to three days before the account holder’s regularly scheduled pay date. AP is not offered by employers, which are typically unaware (or at least not notified) that their employee is participating in the program because it is offered by an employee’s personal financial institution.

Example 1: S is an employee of Company A. S’s paycheck is normally direct-deposited into her checking account with Bank A, an AP program provider, on the last day of the month. Bank A is notified on the 28th day of the month that $1,000 will be transferred by Company A’s bank to Bank A for deposit on the last day of the month. Under the AP program, Bank A deposits $1,000 into S’s checking account on the 29th day of the month, and S can access those funds on that date.

An on-demand pay arrangement (ODPA, also known as an “early wage access” program) is a solution that payroll companies or other ODPA service providers offer employers as an enhancement to the employer’s payroll schedule. Employers provide the ODPA provider each employee’s payroll information (e.g., employment status, wage history, and relevant withholdings). The ODPA provider then permits the employee to withdraw a percentage (or all) of an upcoming paycheck, sometimes as frequently as daily, with the expectation that the ODPA provider will recoup the employee’s withdrawn amount on the next regularly scheduled payday. Further, any excess withdrawals would not be settled by the employer but are instead typically resolved between the ODPA provider and the employee.

Example 2: Company A agrees to participate in an ODPA sponsored by PaydayX, an ODPA provider. Company A provides PaydayX with certain information about its employees, including their normal weekly pay, normally withheld employment taxes, and other pretax and after-tax withholdings (e.g., Sec. 401(k) plan contributions). Company A pays its employees each Friday for services previously provided. Company A’s employees decide whether to establish an account with PaydayX, through which they can access money before Company A distributes paychecks on Friday. Employee C, who has an account with PaydayX, withdraws $100 from his PaydayX account before a Friday. Depending on the ODPA, Employee C may pay a fee to access this money. On the next Friday, $100 is directed from Company A’s bank to PaydayX, and the remainder of Employee C’s paycheck is deposited into Employee C’s bank account (which may also be with PaydayX).

Currently available guidance

Secs. 3102 and 3402 and associated regulations generally require employers to deduct and withhold employment taxes (respectively, Federal Insurance Contributions Act (FICA) taxes and federal income tax withholding) as and when wages are paid, whether actually or constructively. Under Regs. Sec. 31.3402(a)- 1(b), wages are constructively paid when they are credited to the account of, or set apart for, an employee, so that the employee may draw upon those wages at any time, although not then reduced to possession.

Sec. 3401(b) defines payroll periods as the ordinary periods in which wage payments are made and miscellaneous payroll periods as those “other than a daily, weekly, biweekly, semimonthly, monthly, quarterly, semiannual, or annual payroll period.” Employees can only have one payroll period with respect to wages paid by any one employer. For example, if an employer ordinarily pays a particular employee for each calendar week at the end of the week but the employee receives a payment in the middle of the week, the payroll period is still the calendar week. Further, if the employee is paid at the end of a three-week assignment, the payroll period is still the calendar week, and the wage payment is treated as three separate weekly wage payments.

Tax treatment of AP programs

Through an AP program, the employer does not pay employees before their regularly scheduled payday, actually or constructively. Whether or not an employee takes advantage of a financial institution’s AP program, where an amount equal to future wage payments may be accessed by the employee in advance of the employer’s scheduled pay date, the employer will pay the employee’s wages on the employer’s scheduled pay date. As the employer is not involved in advancing wages (or frequently not even aware of whether cash is advanced to its employees by the employee’s financial institution), one could argue under current guidance that there is no change to the timing of the employer’s payroll deposits or the timing of required withholding. The employees may receive funds in their bank accounts early, but the actual wages are not paid by the employer until the normal pay date.

Financial institution employers, however, should take note that if their own employees are taking advantage of an AP program, the wages could be treated as credited to the account of, or set aside for, the employee’s immediate control and disposition as of the earliest possible date of access by the employee. Also, there is a risk of constructive receipt (even if some of the financial institution’s employees do not opt in to be paid early). As such, there is a risk that the employer may face a change to accelerate the timing of its employment tax withholding and deposit.

Tax treatment of ODPAs

Employers using ODPAs generally provide employee wage information to ODPA providers. However, similar to AP programs, the employer does not pay actual wages to an employee before the employee’s regularly scheduled pay date, and the assets used to fund the ODPA come from the ODPA provider.

As such, one could argue that a payment under an ODPA, similar to one made through an AP program, does not accelerate the timing of an employer’s withholding or deposits.

Treasury’s Greenbook proposal

Nonetheless, in March 2022, Treasury, in its General Explanations of the Administration’s Fiscal Year 2023 Revenue Proposals, or “Greenbook,” expressed concern about employees’ ability “to access accrued wages before the end of their regular pay cycle” and suggested that ODPAs do put employees in constructive receipt of their wages.

In a section titled “Clarify Tax Treatment of On-Demand Pay Arrangements,” the Greenbook stated that access to wages before employees’ stated pay date may place them in “constant constructive receipt of their wages as they are earned” and proposed that affected employers should maintain a daily or a miscellaneous payroll period and withhold and pay employment taxes on a daily basis.

Employers or third-party payers probably avoid treating these employees as being in constructive receipt of their wages, however, because of the likely significant financial and administrative burden, Treasury stated. One such potential burden is that employers would be required to “configure their payroll systems and make payroll deposits on a daily basis.” Treasury noted that some employers therefore ignore the constructive-receipt issue entirely or treat the arrangement as a loan from the employer to the employee, treating wages as paid on the regularly scheduled pay dates instead of when they are, in Treasury’s opinion, constructively received. However, Treasury indicated that it does not view such arrangements as loans.

Treasury proposed changes to Secs. 7701, 3401, 3102, 3111, 3301, and 6302, effective for calendar years and quarters beginning after Dec. 31, 2022, as follows:

• Sec. 7701 would be amended to define an ODPA as “an arrangement that allows employees to withdraw earned wages before their regularly scheduled pay dates”;
• Sec. 3401(b) would be amended to provide that the payroll period for ODPAs is treated as a weekly payroll period, even if employees have access to wages during the week;
• Secs. 3102, 3111, and 3301 would be amended to clarify that ODPA payments are not loans; and
• Sec. 6302 would be amended to provide special payroll deposit rules for ODPAs.

While the Greenbook proposal has not yet progressed toward legislation, if it is enacted, employers would be required to adhere to a uniform ODPA system. In the meantime, current laws may be ambiguous and difficult to apply, depending on the specific ODPA system. The proposed uniform system could prove beneficial since it would provide more certainty and possibly reduce liability exposure for employers. Alternatively, however, one could argue that no changes are needed because, under current law, AP programs and ODPAs do not change the time wages are actually or constructively paid for withholding tax purposes.

Other possible effects

Employers should consider myriad effects that AP programs and ODPAs may have on items outside federal employment tax withholding, including the timely transmission of participant contributions to Sec. 401(k) and other retirement plans, the impact to Sec. 401(k) plan loan repayments, contribution timing to flexible spending arrangements and health savings accounts, and any applicable state tax withholding and deposit rules.

Editor Notes

Greg A. Fairbanks, J.D., LL.M., is a tax managing director with Grant Thornton LLP in Washington, D.C. Contributors are members of or associated with Grant Thornton LLP. For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or greg.fairbanks@us.gt.com.