If you do not pay your employees their full wages, you may owe them back pay. Owing back pay is common, and can be caused by an unpaid bonus or missed overtime, among many other reasons.
What leads to back pay?
There are several reasons why you may need to pay your employees back pay.
Commissions: If an employee earned a commission, but you missed the payment or were unable to make the payment, you will owe back pay.
Bonuses: If you intended to pay a bonus that was never received, you will back pay the wages.
Overtime or missed hours: Did you accidentally not pay an employee for the hours they worked? You will back pay the wages. And if it turns out those missed hours push the employee into overtime, you will owe overtime pay as well.
Wrongful termination: If a judge rules you wrongfully terminated an employee, they can require you to give your former employee their job back. You would also have to pay the wages they would have earned while terminated as back pay.
Is back pay the same as retroactive pay?
Back pay may sound like retroactive pay — but it's not.
Retroactive pay, or “retro pay,” is somewhat rare, and is only used if you paid your employee the wrong wages. For example, if you give an employee a retroactive pay increase, that would be considered retro pay, not back pay.
How can I pay back pay?
Here are the three ways to provide back pay for employees.
You can fix your error a few different ways. Here are the three ways to provide back pay for employees.
Process separate pay statements for the historical period(s). You’ll want to clearly label the earning as BACK PAY so you don’t confuse your employee.
Include the back pay on the next scheduled payroll run. Again, label the earning as BACK PAY.
Combine back pay and regular wages on the next regular paycheck. You don’t need to label the earning code as BACK PAY for this option. (Not every state allows this option, so make sure to check with your accountant or payroll processing company.)
You’ll also need to withhold taxes, like social security, Medicare, and any applicable state and local taxes.
However, the process does change a little when it comes to income tax. The IRS defines back pay as “supplemental wages”—that’s paid outside of an employee’s normal pay.
How you withhold the required taxes depends on how you pay the back pay.
If you ran a separate payroll or included and identified the back pay as an earning code on the next paycheck, you have two options:
Use the supplemental tax rate to tax the back pay.
Combine the back pay and normal wages amount from either this payroll or the previous payroll. Then use that sum to figure out the appropriate federal income tax withholding, and subtract the amount withheld or that has already been withheld from the normal wages. Withhold any leftover amount from the back wages.
Added the back pay sum to the next check without specifying what amount was back pay, you’ll withhold federal income taxes from the combined amount like you would for a normal payroll.
Companies using PayNortheast' payroll software will have the benefit of the system automatically calculating, withholding and paying the taxes owed on the back pay earnings.
What is the statute of limitations on back pay?
Generally, a two-year statute of limitations applies to the recovery of back pay. In the case of willful violations, a three-year statute of limitations applies.
Back wages also are available for underpayments to employees under the Davis-Bacon and Related Acts and the Service Contract Act, among other laws enforced and administered by the Wage and Hour Division.
Quick note: This is not to be taken as tax advice. Since tax rules change over time and can vary by location and industry, consult a CPA or tax advisor for specific guidance.