What Is Arrears of Pay and How Is It Calculated?

Arrears of pay refer to money owed to an employee for work already performed but not yet compensated. This situation typically arises due to a delay or an error in the payroll process.

Reasons for Arrears

Several common situations can lead to arrears of pay for employees. One frequent cause involves payroll processing errors, which might include incorrect data entry, overlooked hours, or missed shifts. Delays in implementing pay raises or promotions also commonly result in arrears, where an employee is due a higher rate of pay from a certain date but the updated salary is not reflected in their paycheck until a later period.

Back pay can also stem from labor disputes or settlements, where a resolution dictates that employees receive compensation for past periods at a revised rate. Additionally, retroactive adjustments to wages or benefits, such as a change in commission structure applied to prior sales, can create arrears. Even a late start date for employment, where pay is backdated, might result in an initial payment that includes arrears for the period before the first regular payroll cycle.

How Arrears Are Calculated and Paid

Arrears are calculated by determining the difference between the amount an employee was actually paid and the amount they should have received for a specific period. This calculation often involves comparing the old pay rate to a newly adjusted rate, or identifying missed payments for regular wages, overtime, commissions, or bonuses. For instance, if a pay raise was effective from January but processed in March, the arrears would be the difference for January and February.

The total amount owed is then multiplied by the relevant period, whether it’s hours, days, or months, for which the arrears are due. Once calculated, the payment might be issued as a separate check or added to a regular payroll deposit. The gross amount of arrears is subject to the same deductions as regular wages, including federal, state, and local income taxes, and Social Security and Medicare withholdings.

Tax Implications of Arrears

Arrears of pay are considered taxable income in the year they are received, regardless of when they were originally earned. This means the arrears are added to an employee’s total income for the current financial year. Consequently, they are subject to federal income tax, state income tax, local income tax, and Federal Insurance Contributions Act (FICA) taxes, which include Social Security and Medicare taxes.

The inclusion of a lump sum arrears payment in a single tax year can sometimes push an employee into a higher tax bracket, potentially increasing their overall tax liability. To mitigate this, federal tax law provides relief provisions, such as Section 89, which can help spread the tax burden over the years to which the arrears relate. Employees need to file Form 10E with the IRS to claim this tax relief. Arrears are reported on an employee’s W-2 form for the year they are paid.

Employee Steps Regarding Arrears

If an employee suspects they are owed arrears or receives an arrears payment, reviewing their pay stubs and employment records is a first step. Comparing these documents against their understanding of hours worked, pay rates, and any announced changes can help identify discrepancies. Maintaining detailed records of all communications, payments, and relevant dates is important for future reference.

Contacting the employer’s human resources or payroll department for clarification is the next step to understand the reason for the arrears and confirm the accuracy of the amount. Employees should inquire about the calculation method and the timeline for payment. Understanding their rights, which include the right to timely and accurate payment for all work performed, is an important aspect of addressing arrears.