Should You Loan to Employees? Know Your Options First

When employees turn to you for payroll advances to meet their unexpected cash needs, be sure you understand the impact of turning your business into a lender. While helping an employee with an immediate financial need is a virtuous act that promotes loyalty, there are downsides.

When word gets around, other employees may step forward with requests. If some requests are granted and others are declined, it will impact morale. And since a cash advance is usually repaid from the employee’s future wages, if he or she leaves the company before the debt is repaid, you may have trouble collecting.

Longer-term loans: Unlike a cash advance that is paid back from the next paycheck, an employee loan may be long term. Long-term arrangements should be set out in writing with an interest-bearing promissory note executed by the employee. These promises for repayment are business assets, not expenses. Your bookkeeping simply shows less cash assets and more notes receivable assets.

Failure to establish guidelines could open your business to claims of unfair or illegal discrimination. So if you do decide to provide loans or advances, establish a written policy that specifies qualifications, maximum amounts, and repayment terms.

A gift, not a loan: Lending to an employee also may lead to future requests from the same individual. To avoid this, the employer could make it a one-time gift with clear financial limits that should deter future requests.

Staff gifts are generally accounted for as payroll wage expenses. Employment taxes are applicable, and the transaction is typically treated like any paycheck.