Paper Trails

Navigating deductions from a paycheck with insufficient funds

Dealing with all of the complexities of payroll can be challenging, especially for small business owners busy working their business.  From wage and hour laws to payroll taxes and payroll deductions, staying compliant is a full-time job in itself.  With added payroll deduction rules coming down from federal and state legislators, there may come a time where an employee paycheck has insufficient wages to cover payroll deductions that must be taken from their paycheck.  This is especially prevalent in the hospitality industry where many employees work for tips.

In this article, we will explore some different payroll methods you can use to handle deductions from paychecks when there is insufficient funds.  Some of these methods may work for your particular business and some may not.  But these are ways to ensure compliance and efficiency.  By the end of this article, you’ll have a clearer understanding of how to navigate these issues, reducing stress for both you and your employees.  Always remember to consult your payroll vendor and/or accountant for advice on your particular business needs.

What are payroll deductions?

Payroll deductions are amounts withheld from an employee’s paycheck by the employer. These deductions can vary significantly based on the type of deduction, employee benefits, and legal requirements. Broadly, payroll deductions fall into two categories: pre-tax and post-tax deductions.

Pre-tax deductions

Pre-tax deductions are withholdings from an employee’s paycheck that are taken from the employee’s wages before you withhold payroll taxes on their wages. In fact, these types of deductions are beneficial to both the employer and employee as it lowers the tax liability for both parties. Although the tax liability may be lower in the short term, certain benefit deductions require taxes to be paid in the future. For example, 401(k) contributions are pre-tax deductions, but when an employee retires and begins withdrawing their retirement money, they will then be required to pay taxes on that money. In order for certain qualified benefits to be considered pre-tax deductions, your business must have a Section 125 plan in place.

Post-tax deductions

On the contrary, post-tax deductions are withholdings from an employee’s paycheck that are taken from an employee’s wages after you have withheld payroll taxes on their wages. These types of deductions do not have an effect on the employer or employee’s tax liability. Subsequently, post-tax deductions do not require future tax payments.

Understanding the problem of paychecks with insufficient funds

In the hospitality industry, employees often receive a substantial portion of their earnings through tips.  These employees generally receive a “tipped wage” which is below the state or federal minimum wage.  Employers are allowed to pay tipped employees below minimum wage through the FICA tip credit.  Since these employees’ paychecks are a significantly less amount than those employees receiving at least the full minimum wage, this can lead to situations where their official paychecks amount to $0 after some deductions.

Those employees with a $0 paycheck do not have sufficient funds remaining to cover other payroll deductions.  This poses a challenge for employers who need to deduct things like retirement contributions and additional taxes from these zero-dollar paychecks. Recent Maine legislation, such as Maine’s retirement program, MERIT, and the new Paid Family Medical Leave program, adds to the complexity by requiring additional deductions from employees’ paychecks. Employers must find alternative methods to ensure these deductions are made correctly and timely.

Alternative payroll methods to offset this problem

When traditional payroll methods fall short, employers need to explore alternative strategies. These methods ensure that necessary deductions for retirement contributions, health benefits, taxes and more are made without causing financial strain or compliance issues. Below, we discuss a few effective approaches that can help navigate this challenging aspect of payroll management.

The best solution – paying tips through payroll

One of the most straightforward methods to handle deductions from paychecks without funds is to pay employees their credit card tips through payroll. While this adjustment might initially cause some discontent among employees, it ultimately benefits them by allowing better financial management and preparation for tax time.  We have actually encountered this situation and have a client that made this switch to the dissatisfaction of an employee.  Initially, the employee threatened to quit but within two weeks, the employee was actually thanking their employer as it helped them budget their money more efficiently.  Employees must be willing to change the way they think about their money.

This approach ensures that employees have sufficient funds in their paychecks to cover all deductions, making it the cleanest and easiest solution for employers.

Advantages of paying tips through payroll

  • Employees have the ability to manage their finances more efficiently.
  • Employees are generally better prepared come tax time as they have paid more taxes throughout the year.
  • Employers can easily comply with deduction regulations.

Disadvantages of paying tips through payroll

  • Potential short-term employee frustration.

A good solution – provide a “loan” to employees

While paying tips through payroll is ideal, it might not be feasible for all businesses.

The second way around this is less ideal for both employees and employers.  In this scenario, employers can pay the remittance in advance on behalf of the employee.  Then, employers would pay themselves back by automatically deducting this “loan”  from future employee wages. This scenario is far less ideal, and requires some bookkeeping on the employer end, but can be an option for those not wanting to pay credit card tips through payroll.

Advantages of “loans”

  • Ensures contributions are made on time.
  • Helps maintain compliance.

Disadvantages of “loans”

  • Requires careful bookkeeping.
  • Might complicate payroll processes.

payroll deductions for paycheck with insufficient funds

An okay solution – non-tax pay items

Another method involves adding a non-tax pay item to the payroll, which essentially adds cash to the employee’s check to cover the deduction. For example, an employee gives the employer $100 cash from their tips to add into their pay check. The employer then deposits this $100 cash into the business account and pays out $100 on payroll as a non-taxable item which will add cash to the pay check to cover these mandatory deductions.  This pay item must be non-taxable so the $100 is not eaten up by any outstanding taxes.

In this scenario, the employer needs to account for this in their bookkeeping as an outstanding liability and then credit that back when payroll is run. It should just be an in and an out. It’s advisable that an employer consult with their bookkeeper and payroll company about how to properly handle this reporting.

Advantages of non-tax pay items

  • Ensures deductions are covered.
  • Can be an effective workaround.

Disadvantages of non-tax pay items

  • Requires organized bookkeeping.
  • Not recommended for businesses with less sophisticated accounting processes.


Handling deductions from paychecks without funds requires thoughtful planning and efficient payroll methods. By paying tips through payroll, advancing funds, or adding non-tax pay items, employers can navigate these challenges and ensure compliance with tax and retirement contribution regulations. At Paper Trails, we are committed to assisting small businesses through these complexities, helping you manage payroll and HR with ease. By understanding and implementing these solutions, you can better support your employees and maintain smooth payroll operations.

Contact our team here if you are looking for help with your payroll and HR.