As much as we try to avoid them, employee advances are inevitable in restaurants, bars, and nightclubs. An employee advance is an advance towards an employee’s pay deducted from future paychecks. Advances are issued to employees for various reasons, but they’re typically issued because they need to get paid in advance to cover personal expenses. Advancing pay to an employee should be approached cautiously, as there are many accounting, tax, and legal implications. We recommend you forgo employee advances entirely, but if you must issue them, it’s best to consult an attorney to design and implement an employee advance policy that complies with your local and federal regulations. After implementing an employee advance policy, train your managers to understand and implement the policy and follow the procedures discussed in this article. This article will explain and outline everything you need to know to issue and account for employee advances in your bar, restaurant, or nightclub.
Run Employee Advances Through Payroll
Employee advances can be issued via check, ACH, wire, or any other reasonable payment method (Zelle, Venmo, Paypal, etc.). When issuing the payment, it’s important to identify it as an employee advance so your bookkeeper or accountant knows to treat it as a receivable on the books. Employee advances must be reported through payroll because they are applied toward an employee’s paycheck. An advance is deducted from an employee’s net pay, not their gross pay. In other words, you will not deduct taxes from an advance because the taxes get deducted from the future paycheck to which the advance is applied. For example, assume an employee’s gross pay for a week is $1,000, and after social security, medicare, and income taxes, their take-home pay is $700. A $500 advance towards the employee’s next paycheck would reduce their net pay to $200 ($700 net pay on $1,000 gross pay minus $500 advance).
If you’re issuing an advance that will equal precisely what the employee expects to receive in their next payroll, you must gross up their pay in the next payroll to ensure the net pay equals the advance paid. You can use the paycheck calculator in your payroll system to do this. For example, if the employee’s gross pay is expected to be $900 in their next payroll, and you want to know the net pay so that you can issue an advance for the same amount, you would input the $900 gross pay into the paycheck calculator for that employee, and the payroll system will show you the net pay to issue. You can also do this the other way around. Say you want the employee to receive $750 net pay. You can plug the $750 net pay into the paycheck calculator for that employee, which will gross up the earnings to show the amount recorded on their W-2 and/or paystub. This amount will then be added to the next payroll run, and the $750 advance will be applied so they don’t receive a paycheck, but the payroll gets reported for tax purposes. If the employee will pay back the advance over multiple payrolls, then there is an option in most payroll systems that allows you to apply advances to the net pay.
Some payroll systems allow you to add a check number when applying an advance to a payroll run. The payroll system asks you what check number was used to pay the employee. This will be used for reconciliation purposes and in case you get audited to ensure that the amounts paid to the employee were run through payroll correctly and that you’re not double-dipping on deductions. Ensure the check numbers and amounts from the advance tie to the net pay in payroll; otherwise, this can create a bookkeeping nightmare and lead to double-counting expenses.
Common Mistakes When Processing Advances Through Payroll
Managers may miss an advance and forget to run it through payroll. We’ve seen managers go back and void the payroll and re-run it just to report the advance. This creates many issues, so we recommend running an advance through the next payroll or a special payroll instead of editing the already submitted payroll.
Another common mistake is mis-typing numbers into payroll, which creates a discrepancy between the advance reported through payroll and the advance amount. It’s important to reconcile and double-check the advance amounts, check numbers, and payment breakdown in the payroll system when issuing advances.
What type of payments should be treated as advances?
Any payment in advance towards an employee’s paycheck should be treated as an employee advance. Paying an employee outside payroll due to payroll miscalculation can also be treated like an employee advance. For example, assume you write a check to an employee for 3 missed hours last week after the previous week’s payroll has already been submitted. You must run these three hours through a special or one-off payroll, or give the employee a check and treat it as an advance, then run it through payroll and apply the advance.
A one-time payment to a non-employee service provider must not be run through payroll. Refer to this IRS explanation to determine whether a service provider is an employee or contractor, and this blog to understand the related 1099 implications.
Why run employee advances through payroll?
You must run an employee’s advance through payroll to ensure you and the employee report and pay the proper taxes on their income. You are responsible for the employer’s share of Social Security and Medicare taxes on these wages and withholding the employee’s share of Social Security, Medicare, and income taxes. Failure to withhold and remit these taxes to the IRS and state tax authorities can have devastating and fatal consequences for a business. Click here to learn more.
Running advances through payroll is in the restaurant’s and the employee’s best interest. It legitimizes an employee’s income if they want to take a loan to buy a car or house because it shows up on their W-2. The restaurant can claim this advance as a salary and wages tax deduction on its business returns by processing it through payroll. You can’t have your cake and eat it, too, meaning you can’t claim a deduction for unreported income.
Finally, by running these wages through payroll, you qualify them for the FICA tip credit, which can significantly reduce your restaurant’s taxes.
Accounting and Bookkeeping for Employee Advances
When the advance is issued, it must be recorded as a current asset on the books in the Employee Advances account, which is an Accounts Receivable account – amounts owed to you from your employees and customers. If the advance is deducted from future paychecks, the balance in the Employee Advances account will be reduced by the net pay amount. If this process is followed, the advance will not affect the P&L and/or labor cost.
You should be able to see the running balance of your employee advances (aka the amounts owed from your employees) in real time on your balance sheet. If you’re interested in improving your financial reporting and/or ensuring employee advances are correctly reflected in your financials, don’t hesitate to contact us to see if we’re the right fit for your accounting and advisory needs.
