How to Legally Correct Failures to Withhold Source Deductions

What to Do When You Get a Garnishment Order

Not taking enough of a source deduction out of employees’ paycheques is a common payroll mistake. “Failures to withhold” expose employers to risk of penalties and interest, especially when the error affects deductions required by tax, EI, CPP and other statutes. When and if you discover the mistake, you may seek to correct it by making additional deductions to subsequent payments. However, there are strict limits on making deductions to recover past failures to withhold. Here’s what you can and can’t do to correct a failure to withhold.

The Law of Deductions to Correct Previous Failures to Withhold

Before the advent of employment standards laws, employers were pretty much free to take whatever debts they felt their employees owed directly out of their paycheque. Power over the paycheque essentially made employers judge and jury in every dispute. Employment standards laws rectify this imbalance in power by requiring employers to have specific legal authority to make payroll deductions. Legal authority to deduct comes from 3 basic sources:

i. Statutes

There are some deductions that employers not only may but must make, particularly for government programs including income tax, CPP, EI, and provincial equivalents like provincial income tax, QPP and QPIP.

ii. Court Orders

An employer’s authority to make deductions from an employee’s pay to satisfy a debt may come from the order of a court or other administrative body, such as those that collect family support payments. Such orders are usually generally referred to as garnishments.

iii. Voluntary Consent for Deductions

Employees may also consent to certain deductions for benefits like contributions to retirement plans or to pay dues to their unions. Consent typically must be in writing and can be given under a collective agreement or as part of the sign-up procedure for enrolling in employee benefits programs.

Strategic Pointer

Employers may also be authorized to make deductions to recover the cost of uniforms and debts that the employee owes to the company, e.g., for the cost of damaging equipment.

4 Strategies for Deducting to Recover Previous Failures to Withhold

How you go about recovering a failure to withhold depends on whether the deduction involved was a statutory deduction, a deduction required by a garnishment or one voluntarily consented to by the employee.

1. Failure to Withhold Income Tax

Failures to deduct enough money for income tax often stem from an error in payroll setup, such as entering a higher personal income tax credit than was actually claimed by the employee on the TD1. Such failures to withhold can be costly to employers and result in penalties. In addition, the amount that the employer fails to deduct is subject to interest at a rate specified by the CRA—although the agency can’t double-dip by imposing additional penalties for failing to remit the amount that wasn’t deducted.

The problem is that neither federal nor provincial tax laws require or authorize employers to recover such amounts via source deductions from subsequent paycheques. Result: Deducting shortfalls in withholdings from pay doesn’t enable you to avoid penalties and interest under tax laws but does expose you to the risk of liability for improper deductions under employment standards laws.

2. Failure to Withhold CPP/EI/QPP/QPIP Contributions

Unlike with income tax, you can recover missed deductions for CPP, EI, QPP and QPIP via subsequent deductions without an employee’s consent. However, 2 key restrictions apply:

Deductions Must Be Within 12 Months of Failure to Withhold. Employers may only make deductions from payments made within 12 months of the original failure to withhold. So, by the time you discover the error, it may be too late to make deductions to correct it.

Only One Deduction Can Be Recovered at a Time: In addition, you’re only allowed to make subsequent withholdings to recover failures to withhold EI, CPP, QPP and QPIP one at a time. Example: In 2023, UO Canada Ltd. fails to withhold $25 in EI premiums from an employee’s paycheque over the course of 4 semi-monthly payments: Jan. 14, Jan. 31, Feb. 15 and Feb. 28. Payroll discovers the mistake on Jan. 18, 2024, as it prepares to issue the 2023 T4s.

It’s now too late to get back the $25 missed on the Jan. 14, 2023, payment. But there may still be time to make deductions to recover the other $75 in failures to withhold. But remember: Missed deductions must be recovered one at a time. So, the company can get back the $25 missed on Jan. 31, 2023, from the Jan. 31, 2024, payment; and the $25 missed on Feb. 15, 2023, can be recovered from the Feb. 15, 2024, payment. But because 2024 is a leap year, the $25 missed on Feb. 28, 2023 may not be recovered on the Feb. 29, 2024, payment because the 1-year deadline will have expired.

3. Failure to Deduct for Garnishments

What happens when an employer discovers that it didn’t withhold enough money from pay to cover a garnishment? An employer’s authority to make deductions for garnishments is based on the terms of the actual order. And because orders differ, it’s impossible to provide a general rule. However, employers who discover failures to withhold in response to a garnishment should immediately notify the court or administrative body that issued the order to ask for instructions. You should also ask a lawyer to review the initial garnishment order and offer counsel.

4. Failure to Make Voluntary Deductions

Nothing in the Canadian employment standards deals explicitly with the situation in which the employer fails to take enough for a voluntary deduction out of an employee’s previous pay. Consequently, employers must look at the terms of the document that includes the employee’s actual consent to determine their rights in this situation. Such consent may be contained within the terms of:

The employment agreement;
The collective agreement if the employee is in a union; and/or
The group benefits plan to the extent the consent authorizes deductions for the purpose of contributing to such a plan.

If amounts the employer failed to deduct are relatively small, there probably won’t be a problem with one-time deductions to catch-up on any amounts not previously taken. However, if the amounts concerned are large, employees are probably going to want to spread out the deductions over time.

Compliance Strategy: Address Missed Deductions in Consent to Withhold

When employees consent to voluntary withholdings from their pay, the collective agreement, contract or other document in which the consent is contained should address what, if anything, you can do to make up for missed deductions. Here’s some language you can adapt to your own situation:

Model Language

Missed Deductions: Employer may recover amounts of deduction(s) from Employee’s remuneration that is/are authorized under the terms of this Agreement that it does not make by making deductions from subsequent payments not to exceed [state amount you deem reasonable, e.g., $100] per single paycheque or direct deposit.

Takeaway

Source deduction mistakes happen all the time. The key is to discover them as quickly as possible while you still have time to correct them. However, keep in mind that under the employment standards law, you need express legal authority any time you take money out of an employee’s pay. The source of the authority to make deductions from subsequent payments for failures to withhold from previous ones depends on the source of the authority to make the original deduction. If you overstep the limits of that authority, instead of correcting a previous legal mistake, the new deduction will itself constitute a new legal violation that exposes you to additional liability.

At A Glance: Deductions to Recover Failures to Withhold

You can’t make deductions to recover failures to withhold income tax.
You can make deductions to recover failure to withhold EI, QPP and QPIP: a. within 12 months of the original failure to withhold; and b. one missed deduction at a time.
Deductions to recover failure to withhold under garnishments are based on what garnishment order says.
Deductions to recover failure to make voluntary withholdings are based on what original consent to withhold says.