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If you give an employee an advance and then later forgive the amount, you have created a deduction for yourself and taxable income for your employee.

As far as the bookkeeping entries, initially, the entry would have been to debit a notes receivable for employee advances.

At this point, the employee has to pay the money back, either by giving you the money directly (in which case it wipes out the notes receivable) or deducting the amount from a paycheck.

There is another option and that’s the deduction we’re talking about here – the amount is just forgiven. In this case, you’ll need to ‘gross up’ the amount paid to the employee and on behalf of the employee. So, if your employee got $500 in an advance that you bonused to him, you will have to pay the payroll taxes that normally would have been withheld from his check. That amount needs to be paid to the state and/or federal governments. The bonus then to your employee is $500 + the taxes paid on his behalf. Make sure your payroll company knows about that entry if your bookkeeper doesn’t do the payroll in house..

The total amount – advance + taxes – will be tax deductible.

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