By DANIEL RAY
Special to the Herald-Banner
My father and I own a small specialty manufacturing business in Hunt and Grayson counties. We have been letting longtime and trusted employees who need money borrow it ahead of the pay period, then deducting the money they owe and a small amount of interest from their checks.
These are small loans, and the typical deduction is less than $500 per check with $10 interest on $100 borrowed to keep it simple. My cousin just got an MBA degree and as part of her last project in April, she did a “business review” of our operation. Her teacher says the loan repayment deduction “sounds like it’s probably illegal,” but he couldn’t cite to any laws saying that.
Is what we’re doing illegal, and if so how do we fix it? — Name Withheld, Greenville
Every state has different laws that control paycheck deductions. Most of the Texas rules can be found by searching on the Internet for “Texas Payday Law.” Your loans are not necessarily illegal, but are a bad idea unless you have a very good written contract — for numerous reasons.
Generally, it is legal in Texas for employers to loan money to their employees. It is also generally allowable for those loans to be repaid through payroll deductions, and for some interest to be charged on the money lent.
However, there are three important caveats you should consider.
First, the Texas Payday Law makes it illegal to withhold money from a payroll check for either principal or interest if the deductions are not authorized by the employee in writing. Any loan to an employee should be made through a written contract that includes a specific interest amount, method of calculating interest, and repayment schedule.
Second, you may not pay your employees less than minimum wage in any given work week, even if their “effective wage” — i.e., the hourly pay plus the amount repaid — far exceeds the required minimum wage.
For example, if your employee is paid $14/hour over a 40-hour period, then gets a $280 payment and repays $280 through a paycheck deduction, a legal violation will occur. The employee’s effective pay rate would be $14/hour, but their actual rate would be $7/hour. That would probably be illegal because it falls below the minimum wage requirement for most types of workers.
Third — and most important for you — is that interest charged may not exceed Texas’ “usury” laws. Usury laws are limitations that governments put on the amount of interest that may legally be charged. In Texas, a no-contract loan may not exceed 6 percent interest per year.
Unless you are a regulated lender, a loan through a contract may not exceed 10 percent per year. Regulated and licensed lenders may charge up to 18 percent per year, and out-of-state lenders (such as credit card companies) can charge much higher rates of over 30 percent.
If you are charging $10 per $100 loaned over a short period, the interest you are charging may be 10 times the legal limit — even if you have an otherwise valid contract. You should immediately stop charging interest and repay your employees the illegally-charged interest.
That is something you should do with the help of a CPA, who will also want to consider the tax implications of the initial profit you made on the interest as well as the implications of repayment. Even after you repay the money, you will not be immune to an action from the Texas Workforce Commission, IRS or an employee until all applicable statutes of limitation have passed.
If you did not report that income to the IRS, you must do so before the applicable statute begins to run.
The consequences of a usury or Payday Law violation can be dire, and include criminal charges. In addition to repayment of the amounts owed, I would suggest that you consult with an experienced employment law attorney to determine the best course of action to insulate your business and your family.
If you have a brief legal question on any topic, please forward it to Daniel@smrt-law.com.
Daniel Ray is a Greenville, Texas attorney licensed in all Texas courts. His firm, Scott, Money, Ray & Thomas, PLLC, represents the City of Greenville, Hunt County, and many other public and private North Texas entities. His practice emphasis is civil litigation, wills and trusts and real estate.
This article is intended for entertainment and educational purposes as well as to give the reader general information and a general understanding of the law, not to provide specific legal advice. By reading this article you agree that you understand that there is no attorney-client relationship between you and the author or publisher. The article should not be used as a substitute for competent legal advice from a licensed professional attorney in your area.