On-Demand Payroll & Taxes in 2023

4 minute read

What Is On-Demand Payroll?

On-demand payroll, also known as earned wage access or on-demand pay, is a system that allows employees to receive their wages on an as-needed basis. Instead of waiting for their regular payday, employees can request a portion of their earned wages through a mobile app or online platform. This allows them to access their wages instantly, providing a solution to cash flow problems and unexpected expenses.

On-demand payroll is gaining popularity as more workers seek control over their finances. While On-Demand Payroll can be a valuable tool for employers it also comes with certain challenges, including tax implications and compliance issues.

To implement on-demand payroll, employers must work with a payroll provider that offers this service. The provider establishes a virtual account for each employee, which is linked to the employer's bank account. When an employee requests an on-demand payment, the provider transfers the funds from the virtual account to the employee's bank account.

How Does On-Demand Payroll Work?

On-demand payroll is a system where employees can access their earned wages before their regular payday. The process typically involves a mobile app or online platform that allows employees to request a portion of their wages as an advance. The employer then approves the request, and the money is transferred to the employee's account. Some on-demand payroll providers offer a prepaid debit card for employees to use for these advances.

The amount that employees can access is usually limited, and there may be fees associated with the service. The amount of the advance and any fees are typically deducted from the employee's next paycheck. On-demand payroll can be a useful tool for employees who need access to their earnings before their regular payday, but it's important to understand the terms and fees associated with the service. Employers should also ensure that they are meeting their tax obligations under the constructive receipt doctrine.

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The Pros and Cons of On-Demand Pay

In-demand pay has both advantages and disadvantages that employers and employees should consider before adopting this type of payroll arrangement.

Pros of On-Demand Pay:

  1. Flexibility: On-demand pay provides employees with the flexibility to access their wages when they need it, which can be helpful in case of emergencies or unexpected expenses.
  2. Convenience: On-demand pay is very convenient for employees who need cash immediately, as they do not have to wait for their scheduled payday.
  3. Improved financial wellness: With on-demand pay, employees can better manage their finances and avoid late fees, overdraft charges, and high-interest loans.

Cons of On-Demand Pay:

  1. Fees: Some on-demand pay services may charge fees to access wages early, which can add up over time.
  2. Temptation to overspend: The ease of access to on-demand pay may tempt some employees to spend more than they should, leading to financial problems down the line.
  3. Tax implications: As discussed earlier, on-demand pay can create tax implications for employers and employees if not handled correctly, which can be a headache for all parties involved.

On-Demand Payroll & Taxes

On-demand payroll can have significant tax implications for employers and employees alike. Under the Internal Revenue Code's “constructive receipt” 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.” This means that employers must withhold taxes and make deposits on wages paid through on-demand payroll, just as they would for regularly scheduled paydays. However, the ease of access to wages could create challenges for employers who continue to perform these tasks on a weekly, bi-weekly, or another periodic basis, particularly if they consider the on-demand pay arrangement to be a loan. This could lead to errors in withholdings and deposits, which could in turn result in penalties and interest for both employers and employees.

Furthermore, if on-demand pay is considered paid the day employees request that employers pay them, employers may not be meeting their deposit obligations or calculating withholdings if they continue to perform these tasks weekly, bi-weekly, etc. To avoid these issues, some employers and payroll providers have sought to treat the on-demand pay as a short-term, low-to-no-interest loan from the employer to the employee, or have placed restrictions on employees' use of on-demand wages, such as making only a portion of a day's wages available immediately. However, it is not clear whether these efforts will be sufficient to satisfy the IRS under the constructive receipt doctrine.

To address the issue, the US Department of the Treasury has proposed amending various sections of the Internal Revenue Code to provide a uniform and administrable system for on-demand pay arrangements. Specifically, the department proposes to define on-demand pay “as an arrangement that allows employees to withdraw earned wages before their regularly scheduled pay dates,” and to provide that on-demand pay be treated as a weekly payroll period. The proposed changes would also clarify that on-demand pay is not a loan and provide special payroll deposit rules for on-demand pay arrangements. These changes would provide certainty and uniformity for taxpayers and establish a consistent system for the IRS to administer.

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