Payroll in Practice: 3.10.2025

Question: An employee resigned, and because of timing issues related to state final payment requirements, final wages were erroneously overpaid by $3,000. The employee refuses to repay the overpayment, and the employer plans to refer the matter to a collection agency. Can the employer recover its share of the Social Security and Medicare taxes?

Answer:Administrative errors, including mistakes made when terminating employees, are the most common cause of wage overpayments. The employer has a right to recover overpaid wages regardless of the cause, but states place varying limitations on that right. For example, states may place deadlines by which debts collections must begin and limit the amount that might be collected from an employee’s weekly pay. At the federal level, the Fair Labor Standards Act restricts wage deductions to protect minimum wage and overtime pay requirements.

If an overpayment is not recovered, it is treated as taxable wages to the employee, along with the taxes withheld from the payment. As with any other taxable wages, wage overpayments are subject to employment taxes. The $3,000 will be treated as regular wages, and the Social Security and Medicare (FICA) taxes will be computed as usual, including the employer share. The employer’s share of FICA taxes cannot be recovered unless the overpayment can be recovered from the employee.

If the wages are partially recovered, the recovered amount is treated as gross wages. In addition to net pay, withheld employee taxes, and possibly benefit deductions, are included in the amount. The employer refunds to the employee any of the repaid tax or benefit amounts that it has not deposited or that it can recover from the tax agencies or benefit providers. Any unrecovered gross pay, including net pay, withheld tax, or benefit deductions, remains wages for all tax purposes.

If the overpayment is fully recovered before the end of the calendar year in which the overpayment occurs then federal taxes, including employer shares, can be adjusted to the correct amounts by amending the appropriate Forms 941, Employer’s Quarterly Federal Tax Return. This adjustment applies to federal income, FICA, and Additional Medicare taxes.Claims or adjustments of overcollected taxes are made on Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund. The employer is to refund overcollected amounts to the employee. Similar adjustments may be necessary for appropriate state and local taxes.

Any portion of the overpayment that is not recovered by the end of the calendar year in which it occurs remains taxable wages for both the employee and employer for all tax purposes for that calendar year. Once the calendar year ends, the employee must repay the gross amount, including all withheld taxes. If a partial payment is made, it is treated as a repayment of a portion of gross pay including withheld tax.

For a subsequent-year repayment, whether in full or in part, the employer must refund to the employee any withheld FICA tax attributable to the amount repaid. Only after refunding the amount to the employee can the employer recover the employee share of FICA from the IRS. The employer will also have to correct Forms W-2, Wage and Tax Statement, and amend Forms 941 to report the changes to FICA wages and taxes for the period in which the overpayment occurred. The employer may also recover its share of the taxes attributable to the amount repaid by the employee.

Withheld amounts for income and Additional Medicare taxes may not be adjusted after the end of the calendar year. The employee must still repay that part of the overpayment to the employer. Any amount, whether net pay or withheld tax not repaid, remains overpaid and taxable as wages to the employee.

Repayment in a subsequent year does not affect any payroll amounts for the year of repayment. Even if the overpayment is recovered through payroll deductions during the subsequent year, it is an after-tax deduction and does not affect the subsequent year’s taxable wages or taxes.

From the employee’s standpoint, amounts repaid to the employer in a subsequent year remain taxable income for income tax purposes for the year of overpayment. Repayment to the employer does not require an amended income tax return for that year. Instead, the employee may be allowed a credit or deduction on the tax return for the year the money was repaid. The income and Additional Medicare taxes withheld in the year of overpayment are applied as credits on the employee’s income tax return for the overpayment year.

This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., or its owners.

Author Information
Patrick Haggerty is the owner of a tax practice in Chapel Hill, North Carolina, and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

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