By US Treasury rules, a salary advance is a taxable event to the recipient; and on the empoyer's side, it’s recorded as a prepaid payroll. When the advance is paid back (or, more likely, earned) then the prepaid payroll account is credited for the amount earned. Taxes such as FICA, Medicare, Federal and state withholding need to also be withheld from the advance.
As it can happen, sometimes an advance is just that, money advanced to an employee for an emergency and the employee intends to repay the advance within a short time period. Can this type of an advance avoid the prepaid payroll treatment?
We think so if, and only if, the employee signs a short-term note agreeing to repay the advance either all at once, say in three months, or perhaps weekly, a certain amount each Friday for instance. Of course the note agreement must contain a reasonable interest rate but with a solid commitment from the employee to repay the advance it seems to us that the correct treatment of this advance is as a loan receivable by the employer and not as a prepaid payroll item.
Jeremiah K. Murphy, CPA is an accounting firm providing tax services, audits and business consulting.