Employee loans are typically the result of an employee’s desperate plea. In granting your employee’s request, you may feel that you are doing a good deed. However, your best intentions can backfire on you, as employee loans inevitably pose many unintended issues and pitfalls for the unsuspecting or naïve employer.

Consider these seven questions before you rush to your employee’s financial rescue:

1. Will you be punished for your good deed? In loaning money to an employee, you might believe that your benevolence will protect you from problems later. Unfortunately, previous good intentions are not reliable protection for an employment/lending relationship gone bad. A failure to deal with the issues beforehand and properly document the loan can be doubly costly to you; not only may the loan be uncollectible, but it may also create unintended liability for you.

2. Are you a lender? Remember that, by loaning money to employees, you are now a “lender” subject to federal and state law regarding the loans and collections. Depending on the type, frequency and amount of the loan, the interest rate, security (if any), the intended use of the loan proceeds and other factors, you may become subject to consumer lending laws, state small loan laws, usury laws and more.

3. Have you thought about the taxes you will pay on the interest? If you think you are giving the employee an “interest-free” loan, think again. Generally, the IRS will require you to recognize interest income even if the loan does not bear interest. Make sure you keep this in mind when documenting the loan.

4. Are you a “loan shark?” Depending on your location and the employee’s location, interest and other charges may be deemed illegal “usury,” subjecting you to civil and criminal penalties. Even low-interest loans, if not documented properly, can fail to comply with usury laws.

5. Advances and draws are loans … or are they? At least one employer allowed its commissioned salespeople to take “advances” or “draws” against future commissions, trusting that everyone would agree that these were loans that the salesperson would repay, regardless of whether there would be sufficient commissions to pay them. The employer was shocked when the employee accumulated a large number of “draws,” earned little in the way of commissions, quit their job and then claimed that they understood that the “advances” or “draws” did not have to be repaid! If the employer had consulted with an attorney beforehand, they could have avoided this unfortunate “misunderstanding.”

6. Payment on default? How do you collect if the employee doesn’t pay? Make sure you have the employee’s permission before deducting any loan payments from their wages. Also, think about how you will collect the loan if the employee leaves you to work for someone else.

7. Are you protected if you just forgive the loan? No! How would you like to forgive an employee loan, only to have the employee take your confidential information, defame you in social media, or sue you later for some other reason? Even if you decide to forgive an employee loan, at least make sure to obtain proper releases of claims from the employee and confirmations of their confidentiality, non-compete and other obligations to you.

Do you have questions about employee loans or compensation issues? Schedule a planning meeting with Phil Glasscock by calling 480-941-4359, or email jpg@jpglaw.com.