Deducting Loan Balance from Final Paycheck

November 13, 2018

You cannot deduct the full balance of an employee loan from the employee’s final paycheck.

You can only deduct the approved payment amount from the final paycheck upon employee termination, not the full remaining balance. The possible exception is if the employee signs a new written agreement at termination authorizing the deduction of the full unpaid balance from the final paycheck.

If you choose to loan an employee money, the very smart approach is to handle such loans through payroll and not through Accounts Payable. Here’s why:

  • PaySmart can determine what is taxable and make any relevant deductions.
  • If the employee does not repay the loan before termination, the unpaid loan amount is taxable income.
  • If the company charged a rate lower than the market rate, the difference between market interest and loan interest is taxable income.

Employee loans can get complicated, so PaySmart recommends running this issue by legal counsel. Also, be sure to get everything in writing and signed by the employee and a company representative.