HR Hotline: Is the Paycheck Good Security for an Employee Loan?

Q: Occasionally we loan money to an employee or permit an employee to make a personal purchase on the company account, with the understanding that repayment will come in the form of a specified amount deducted from his or her weekly paycheck. What are our options if the employee quits or is discharged before repaying the debt?

A: If your company’s name includes the words bank and trust, credit union, savings and loan, or some other reference to financial services, and employees are permitted or encouraged to use the organization’s products or services, you should structure the relationships (employer-employee, creditor-debtor) so that each is independently managed under proper standards and will survive the termination of the other.
If you are not in financial services, approach employee loan arrangements with caution. Becoming a creditor of your employees adds another complicating element to the relationship if all is not going well. Nevertheless, loaning money to employees is a common practice, and repayment typically takes the form of deductions from periodic paychecks and/or a final paycheck.
In either case, you should be familiar with the state law (CGS 31-71e) that makes clear how deductions from employee paychecks should be handled in a variety of circumstances.
The relevant text of that law forbids withholding any portion of an employee’s paycheck “unless (1) the employer is required or empowered to do so by state or federal law, or (2) the employer has written authorization from the employee for deductions on a form approved by the [labor] commissioner, or (3) the deductions are authorized by the employee, in writing, for medical, surgical or hospital care or service.”
Your situation falls into the second scenario and requires the employee’s written permission on a form approved by the state Department of Labor. You might consider adding the following short statement to the form (taken from another form used to document repayment of vacation pay advances): “Allow the company to deduct any amount which I owe from my last paycheck and/or any future commission checks which may be due to me after the termination of my employment.”
Using a DOL-approved form will protect your right to recover your money from the employee’s paycheck(s). Without using an approved form, in the event of an employee complaint or labor department audit or investigation, you may have to reimburse the employee for unauthorized paycheck deductions and seek other means of reconciling the debt, such as small claims court.
Other common paycheck deductions, such as required payroll taxes under state and federal law (the first scenario above) don’t require employee authorization. In fact, you would find yourself in hot water if you didn’t make these deductions, regardless of the employee’s willingness.
Deductions for group insurance contributions (the third scenario above) must be authorized in writing but need not be documented on a DOL form.