Author Topic: Salary advance implications  (Read 9850 times)

Beaker

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Salary advance implications
« on: June 24, 2013, 09:18:54 AM »
I work for a very small startup software company. Recently management said that they're going to be paying our salaries as advances, rather than as regular payroll, in order to conserve cash. My understanding is that the take-home pay is the same, but they can get away with not paying withholding taxes right now thus conserving cash. The idea is that the cash situation will improve by the end of the year via sales or additional investment financing, allowing them to pay all the skipped taxes.

I understand this has some very bad implications about the financial stability of the company, but I don't need advice about that - I'm already looking for other jobs. But this payroll advance mechanism is outside my experience, and I don't know what if anything to do about it. If the company goes bankrupt before paying the back taxes, is the IRS going to come after me to pay them? If I resign, could the company ask for those "advances" back, even though they're really my salary? Heck, is this even a legitimate and legal thing for them to do?

I don't even know where to go to ask about this sort of thing. Google searches keep landing at payday loan operations, which is obviously not the same thing. Any ideas or info would be appreciated.

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Re: Salary advance implications
« Reply #1 on: June 24, 2013, 10:53:21 AM »
breischl - I've created two startups (one a failure, the second a modest success). You are correct: this is a desperation move that should alarm you. You're smart to be actively looking for a new job.

When the company withholds on your behalf, all they are doing is sending the federal (and state if applicable) governments estimated taxes you owe. Theoretically, you could not have anything withheld (which you can kinda sorta do by fiddling your withholding declaration when you start working at any new job) and simply write a personal check for the taxes owed when you file your taxes the next April. Note this assumes you are saving enough to pay the entire tab when it comes due!

When your employer does not withhold, you are left with a tax obligation toward which you have had nothing withheld. Here's what's happening (I'll use very oversimplified numbers):

Let's say previously your gross pay for a month was $1,000 and your net ("take-home") was $800 with $200 withheld. If your actual tax liability for that month ended up being $200, you owe nothing when you file.

Now let's say you're getting that "same" pay as an "advance" with no withholding. Your company tells you "Your take-home pay stays the same" and writes you a check for $800. You owe taxes on income of $800 for that month. Nothing has been withheld. Assuming the same 20% tax rate I used above, you now have a tax liability of $160.

As you are being paid this way, you are building up a tax liability. Reality is that, using the example numbers, you are being paid $640 (if you net out your no-more-withholding liability) for work you used to be paid $800 (net after withholding) for. You are subsidizing your company's on-going existence by taking an effective pay cut.  (I suspect they are also fiddling both your and their FICA (Social Security) contributions as well - if that's true, you may have a FICA obligation as well as a plain vanilla income tax liability.)

If you're ok with the effective pay cut and the accumulating tax liability, be sure you save up to pay those taxes next April.

Beaker

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Re: Salary advance implications
« Reply #2 on: June 24, 2013, 12:56:56 PM »
Thank you for that very detailed response. That's about what I feared.

Since this does amount to a pay cut, I think this probably violates at least one state law. They also haven't provided a pay stub (since it's not really pay), which violates a different section of the same law. So I may be having a conversation about them just paying me what they promised.

RewardTraveler

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Re: Salary advance implications
« Reply #3 on: June 25, 2013, 08:28:57 AM »
Even if they're providing you an advance, it seems like they would still be required to pay you minimum wage (if you're hourly) or some minimum salary (I think it's ~$23k if you're a salaried/exempt employee).  Since they're not providing pay stubs, it doesn't seem likely this is happening.  Are they basically saying they won't pay you for the next 3 months, then they following 3 months they will pay you double?

One thing that would concern me is if you are looking for a job and you decide to leave your current employer, will you be required to pay back your advances?  It seems like a possibility.

I don't know how they structured it, but it seems like you would be most protected if they structured it so that payday is more spread out.  Instead of paying you every 2 weeks, they now pay you every 3 months.  In between payday they advance you your "2 week" salary every 2 weeks, but they wouldn't actually issue a pay stub for 3 months.  This would keep your compensation the same and you would likely be protected should you leave the company (they are legally required to pay out any unpaid wages when you leave).

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Re: Salary advance implications
« Reply #4 on: June 25, 2013, 08:57:20 AM »
RewardTraveler brings up a good point - have they asked you to sign anything saying something like "I accept this as an advance against future hours worked?"

If not, I wouldn't worry about paying them back if you leave. They are hanging their posteriors so far over the side of the boat that the merest threat of lawsuit / exposure would shut them up. But if you have signed something, revoke it or confront them. If they are positioning your current paycheck as pay advanced against future hours work, then you are working for free today, yes?

I disagree however with the idea of trying to twist it so that you are paid less often. That puts you at more risk of simply being stiffed. The company being legally obligated to pay you unpaid wages when you leave is meaningless with stressed / dishonest management.

fiveoclockshadow

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Re: Salary advance implications
« Reply #5 on: June 25, 2013, 10:58:41 AM »
Besides the fact this sounds like a company headed down the tubes as described it doesn't even sound quite legal.  See this reference regarding advances vs. wages:

http://www.bizfilings.com/toolkit/sbg/tax-info/payroll-taxes/what-constitutes-taxable-compensation.aspx

Now, I've been at a startup and had friends at startups where things are done with wages to help *short term* cash flow issues.  By which I mean you've got invoices out on net-15 or net-30 while you also have big un-shipped inventory for booked orders.  That's cash flow.  That's different from "we expect to get a big order soon" or "we have new investors just around the corner" which is just wishful thinking.

In these short term cash flow situations what I've seen done is higher salary key players, usually with equity as well, will take temporary pay cuts to lower their wages and that means their take home actually goes down to.  They will get more pay later when the cash flow balances.  They are taking a bit of a risk, but they know it and agree to it. 

Similarly, in some cases such key players have large deferred travel expense reimbursements on the books.  If said employee has their own short term cash flow issues (i.e. they can't have their take home go down right now) one option is to drop their wages to minimum but pay out more of their expenses.  Since the expense reimbursements don't require payroll, SS, medicare or withholding it costs the company less for each dollar that ends up in the employee's hands.  Again, this is of course done with the employee's consent and is dependent on the employee already having allowed the company to delay reimbursing in the past.

Anyway, I'd be uncomfortable in your situation until I knew more and had the company clearly explain to me what they are doing, how it appears on my pay stub and what risks I am taking.

Beaker

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Re: Salary advance implications
« Reply #6 on: June 26, 2013, 08:30:14 AM »
Quote
Even if they're providing you an advance, it seems like they would still be required to pay you minimum wage
I'm still well above minimum wage. The $1000/month example from earlier was just a fictitious number for expository purposes.

Quote
Are they basically saying they won't pay you for the next 3 months, then they following 3 months they will pay you double?
It's more like they're paying me, but not paying the government. But that just means that next April 15th there's going to be a tax bill with no withholdings against it, and the IRS is going to make somebody to pay it.

Quote
have they asked you to sign anything saying something like "I accept this as an advance against future hours worked?"
No, nor would I sign such a thing. Though I think asking employees to take a straight up paycut, with some prior explanation, would've been a less shady way to handle the situation.

Quote
One thing that would concern me is if you are looking for a job and you decide to leave your current employer, will you be required to pay back your advances?  It seems like a possibility.
It hasn't been discussed, but I'd like to see them try and make that stick. Though I guess it's possible they could just declare bankruptcy, in which case I'd probably be hosed.

It has occurred to me that this is a transparent attempt to avoid paying taxes. I have no specific knowledge of a federal law that this would violate but I know the IRS usually frowns on things that are done solely to dodge taxes with no other business justification. Also, an advance is a payment for services not yet performed, but we're paid in arrears. So it appears that they're intentionally miscategorizing income for the purposes of avoiding taxes. Again, it seems like the IRS would be displeased.

Additionally, I think this runs afoul of the Colorado Wage Act. The "Pay Statements" section says I should get a paystub with withholdings itemized, but of course there isn't one because they didn't do withholdings. The "Pay Periods and Paydays" section says that I have to be paid (not advanced) every 30 days, which has been missed. The "Wages Owed/Paid on Demand" section says they have to pay my back wages. And the "Nonwaiver of Rights" section says I couldn't waive those rights even if they had given me something to sign.

My current plan is to let this be for now, and quit as soon as I can find another gig. At that point I'll demand that they square up all the "advances" into proper salary with paid-up withholdings and provide pay stubs to prove it. If they balk at that, then I can file a complaint with the state Department of Labor, and possibly the IRS if I can figure out how. Hopefully the threat alone will be enough to settle things.

Thanks again for all your thoughts on this, everyone.

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Re: Salary advance implications
« Reply #7 on: June 26, 2013, 08:36:22 AM »
If they are not withholding, they are almost certainly in violation of federal law:
http://www.irs.gov/Individuals/Employees/Tax-Withholding

Good for you - I think you're taking exactly the right steps. Love that you have researched applicable Colorado laws.

Beaker

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Re: Salary advance implications
« Reply #8 on: June 26, 2013, 09:04:50 AM »
The note about Estimated Taxes on that page led me here, which makes it sound as if all the employees may have to file estimated taxes if this goes on for three months or more. Yay.

The more I look at this, the more I'm thinking I need to bring it up ASAP rather than when I leave. The worst they can do is fire me, which might be a blessing at this point.

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Re: Salary advance implications
« Reply #9 on: June 26, 2013, 10:02:53 AM »
You are correct: you will need to file estimated taxes after three months. (That's actually for the good. The worst would be to go until April 2014 without understanding how much you owe on June - Dec 2013 "advanced earnings.")

Beaker

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Re: Salary advance implications
« Reply #10 on: July 11, 2013, 02:36:51 PM »
I thought you all might be interested in the epilogue.

Two weeks after they announced the whole "cash advance" fiasco, my company laid me off with two weeks severance. This was thoroughly unsurprising for a number of reasons, including a number that aren't worth mentioning here. I made damn sure my final check included a paystub indicating properly paid withholding taxes, though I'm still trying to get that cleaned up for the prior pay period. They were quite apologetic and seemed to feel pretty bad about it.

I, on the other hand, was practically ecstatic. My new job search had been fruitful and I had a third interview scheduled at noon the same day, and they later offered me a better job than what I had. So basically I got paid to leave a job that I would've quit a few days later. You can't beat that.

Thanks again for all the advice!

Eric

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Re: Salary advance implications
« Reply #11 on: July 11, 2013, 02:42:29 PM »
So basically I got paid to leave a job that I would've quit a few days later. You can't beat that.

That's awesome!

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Re: Salary advance implications
« Reply #12 on: July 11, 2013, 02:48:00 PM »
What a great example of being smart and not needing a 2nd bite to know it's a s**t sandwich.

Bravo, breischl, bravo - enjoy that first fat check at your new, better job.

fiveoclockshadow

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Re: Salary advance implications
« Reply #13 on: July 11, 2013, 05:07:28 PM »
Congrats on your new and improved job!  Glad everything worked out and thanks for updating us.

arebelspy

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Re: Salary advance implications
« Reply #14 on: July 11, 2013, 05:12:41 PM »
So basically I got paid to leave a job that I would've quit a few days later. You can't beat that.

Hah, excellent!

Glad it all worked out, thanks for the exciting conclusion.
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Zamboni

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Re: Salary advance implications
« Reply #15 on: July 11, 2013, 05:28:24 PM »
Yay!  I am happy for you.


Rebecca Stapler

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Re: Salary advance implications
« Reply #16 on: July 11, 2013, 07:39:26 PM »
Fabulous! Good for you for starting the job search once the writing was on the wall!