[US] Tax implications linger for on-demand pay

According to research, more than 60 per cent of US workers would like to be able to access their earnings before their regularly scheduled paydays. In response, many employers and their payroll providers now offer so-called on-demand pay arrangements that allow employees to receive their wages the same day they earn it.

On-demand pay is a valuable recruiting and retention tool for employers but the immediate availability of wages carries with it certain tax implications for employers that may not easily be avoided without updates to the tax laws and regulations. The National Law Review takes a closer look at these implications.

What Is On-Demand Pay?

On-demand pay - also referred to as “earned wage access programs” - is a contemporary alternative to payday lending which some consumer advocates have criticised as predatory due to its high fees and interest. Unlike payday lending, on-demand pay arrangements are not structured as a loan in the same way and carry fewer fees, if any at all.

On-demand pay services often require employees to specifically request access to wages through a mobile app (not to be confused with mobile apps offered by third-party companies that operate as payday lenders). Some on-demand pay systems only allow money to be deposited into a prepaid debit card issued by the payroll provider.

The IRS Constructive Receipt Doctrine

However, such ease of access could trigger tax obligations due to the Internal Revenue Code’s “constructive receipt” doctrine. Under this doctrine, wages are considered paid once the wages are “set apart for” the employee “or otherwise made available so that [the employee] may draw upon it at any time,” regardless of whether the employee withdraws or spends the money. As the Internal Revenue Service (IRS) views it, the wages are paid once the employee has “unfettered control over the date on which they actually receive their wages.”

When employers pay wages or an employee constructively receives wages, employers are obligated to withhold taxes and make deposits. Employers typically make the deposits on a weekly, bi-weekly, semimonthly, or another periodic basis, in accordance with their payday schedules. If on-demand pay is considered paid the day employees request it from their employer, employers may not be meeting their deposit obligations or properly calculating withholdings if they continue to perform these tasks weekly, bi-weekly, etc.

Employer’s Pay Options

In part to avoid this issue, The National Law Review says some employers and payroll providers offering on-demand pay have sought to treat the on-demand pay as a short-term, low-to-no-interest loan from the employer to the employee. Alternatively, employers have placed restrictions on employees’ use of on-demand wages, such as making only a portion of a day’s wages available immediately.

It is unclear whether these efforts will be enough to satisfy the IRS under the constructive receipt doctrine. In the U.S. Department of the Treasury’s March 2022 “Greenbook” outlining revenue proposals for the fiscal year 2023, the department reportedly identified that employees with access to on-demand pay might be in constant constructive receipt of their earned wages. The department stated that employers that offer on-demand pay arrangements should “withhold and pay employment taxes on employees’ earned wages on a daily basis.” The department also highlighted a potential problem in that employers and third-party vendors are unlikely to make payroll deposits on a daily basis and some “ignore the constructive receipt issue entirely or treat the arrangement as a loan.” The result either way, according to the department, is that “wages are treated as paid on regularly scheduled pay dates, rather than when constructively received.”

As a result, the department urged Congress to enact legislation to ease the administrative complexity. Specifically, the Department of the Treasury proposed amending:

• Section 7701 of the Code to define on-demand pay “as an arrangement that allows employees to withdraw earned wages before their regularly scheduled pay dates”;
• Section 3401(c) of the Code to provide that on-demand pay be treated as a weekly payroll period;
• Sections 3102, 3111, and 2201 of the Code to clarify that on-demand pay is not a loan; and
• Section 6302 of the Code to “provide special payroll deposit rules for on-demand pay arrangements.”

These changes “would provide certainty and uniformity for taxpayers and would establish a uniform and administrable system for the IRS,” the department said.

Overview

On-demand pay has its benefits and is appreciated by employees, however, it could create tax liability exposure for employers and their employees. This exposure exists until legislative changes are made to change how on-demand pay is treated under the Internal Revenue Code. Employers and payroll vendors should consider configuring on-demand pay systems to make payroll deposits on a daily basis but this might present administrative complexity. Alternatively, employers may want to consider placing restrictions on access to on-demand pay to avoid employees’ constructive receipt of wages.

Source: The National Law Review

(Link and quotes via original reporting)

According to research, more than 60 per cent of US workers would like to be able to access their earnings before their regularly scheduled paydays. In response, many employers and their payroll providers now offer so-called on-demand pay arrangements that allow employees to receive their wages the same day they earn it.

On-demand pay is a valuable recruiting and retention tool for employers but the immediate availability of wages carries with it certain tax implications for employers that may not easily be avoided without updates to the tax laws and regulations. The National Law Review takes a closer look at these implications.

What Is On-Demand Pay?

On-demand pay - also referred to as “earned wage access programs” - is a contemporary alternative to payday lending which some consumer advocates have criticised as predatory due to its high fees and interest. Unlike payday lending, on-demand pay arrangements are not structured as a loan in the same way and carry fewer fees, if any at all.

On-demand pay services often require employees to specifically request access to wages through a mobile app (not to be confused with mobile apps offered by third-party companies that operate as payday lenders). Some on-demand pay systems only allow money to be deposited into a prepaid debit card issued by the payroll provider.

The IRS Constructive Receipt Doctrine

However, such ease of access could trigger tax obligations due to the Internal Revenue Code’s “constructive receipt” doctrine. Under this doctrine, wages are considered paid once the wages are “set apart for” the employee “or otherwise made available so that [the employee] may draw upon it at any time,” regardless of whether the employee withdraws or spends the money. As the Internal Revenue Service (IRS) views it, the wages are paid once the employee has “unfettered control over the date on which they actually receive their wages.”

When employers pay wages or an employee constructively receives wages, employers are obligated to withhold taxes and make deposits. Employers typically make the deposits on a weekly, bi-weekly, semimonthly, or another periodic basis, in accordance with their payday schedules. If on-demand pay is considered paid the day employees request it from their employer, employers may not be meeting their deposit obligations or properly calculating withholdings if they continue to perform these tasks weekly, bi-weekly, etc.

Employer’s Pay Options

In part to avoid this issue, The National Law Review says some employers and payroll providers offering on-demand pay have sought to treat the on-demand pay as a short-term, low-to-no-interest loan from the employer to the employee. Alternatively, employers have placed restrictions on employees’ use of on-demand wages, such as making only a portion of a day’s wages available immediately.

It is unclear whether these efforts will be enough to satisfy the IRS under the constructive receipt doctrine. In the U.S. Department of the Treasury’s March 2022 “Greenbook” outlining revenue proposals for the fiscal year 2023, the department reportedly identified that employees with access to on-demand pay might be in constant constructive receipt of their earned wages. The department stated that employers that offer on-demand pay arrangements should “withhold and pay employment taxes on employees’ earned wages on a daily basis.” The department also highlighted a potential problem in that employers and third-party vendors are unlikely to make payroll deposits on a daily basis and some “ignore the constructive receipt issue entirely or treat the arrangement as a loan.” The result either way, according to the department, is that “wages are treated as paid on regularly scheduled pay dates, rather than when constructively received.”

As a result, the department urged Congress to enact legislation to ease the administrative complexity. Specifically, the Department of the Treasury proposed amending:

• Section 7701 of the Code to define on-demand pay “as an arrangement that allows employees to withdraw earned wages before their regularly scheduled pay dates”;
• Section 3401(c) of the Code to provide that on-demand pay be treated as a weekly payroll period;
• Sections 3102, 3111, and 2201 of the Code to clarify that on-demand pay is not a loan; and
• Section 6302 of the Code to “provide special payroll deposit rules for on-demand pay arrangements.”

These changes “would provide certainty and uniformity for taxpayers and would establish a uniform and administrable system for the IRS,” the department said.

Overview

On-demand pay has its benefits and is appreciated by employees, however, it could create tax liability exposure for employers and their employees. This exposure exists until legislative changes are made to change how on-demand pay is treated under the Internal Revenue Code. Employers and payroll vendors should consider configuring on-demand pay systems to make payroll deposits on a daily basis but this might present administrative complexity. Alternatively, employers may want to consider placing restrictions on access to on-demand pay to avoid employees’ constructive receipt of wages.

Source: The National Law Review

(Link and quotes via original reporting)