The Maryland Office of Financial Regulation (OFR) issued guidance on Earned Wage Access (EWA) products, also known as "on-demand pay," clarifying when these products represent loans or wage advances and the requirements that apply to independent third-party EWA providers.

EWA is a relatively new financial product that allows employees to obtain an advance against wages they have already earned, but not yet received. Employers can offer EWA products directly to employees or consumers can access the service through independent third-party providers.

Is EWA a loan or an advance?

Loan

Maryland Commercial Law Section 12-303(a)3(iii) does not apply "to a loan between an employer and an employee." Therefore, if the employer provides the EWA product directly to employees at no cost, the wage advances are not considered loans subject to the Maryland commercial Law.

If a Maryland consumer receives an EWA payment from an independent third party, the facts and circumstances must be analyzed to determine if those independent third parties are considered lenders and whether they require a lender license.

Advance

If the EWA payment is limited to the wages the employee earned to date and is provided directly by the employer, it is not a wage advance because the employer owes the employee the funds.

Are EWA fees and "tips" permissible?

A tip or fee given to an EWA provider is compensation for an extension of credit; accordingly, whether a tip or fee is permissible depends on the amount of the fee/tip and whether the employer or the independent third party is providing the product.

If the employer provides the product directly to the employee, the tip or fee is not considered a loan and interest rate limits do not apply.

If a third-party provides the product, the tip or fee is a loan, and the lender must adhere to Maryland interest rate limits. In some instances, the tip would factor into the interest rate on the loan product. Maryland Commercial Law Section 12-306 caps the amount of interest a lender may charge a consumer on a transaction.

Is EWA offered directly by the employer or an independent third-party?

To determine if the third-party provider is a service provider to the employer or an independent third party (and thus, a lender), the OFR will consider the following:

Who bears the economic risk?

If consumers default on their repayment obligations and the third party bears the loss (instead of the employer), the OFR will likely view the third-party as the service provider and not the employer.

What level of contact does the third party have with the consumer?

If the consumer has minimal to no contact with the third-party provider, OFR is likely to view the third party as a vendor/service provider to the employer. The greater the level of contact the consumer has with the third party, the less it will appear to be merely a service provider to the employer.

Who benefits from any fees or "tips" the consumer pays?

If the third party receives most of the economic benefit, they are more likely to be viewed as the lender and not a vendor/service provider to the employer. This is particularly true if the consumer pays the "tips" or fees directly to the third party instead of the employer.

Ernst & Young LLP insights

It is unclear the extent to which this OFR guidance extends to Maryland income tax withholding.

For income tax withholding purposes, Maryland generally follows the federal Internal Revenue Code (IRC). (Maryland Withholding Guide, p. 5: Md. Code Ann. Tax-Gen. Section 10-905(e-1).)

Under IRC Section 451, wage advances are subject to federal withholding when paid, meaning that withholding of federal income tax, Social Security and Medicare tax is required from wage advances at the time they are available to the employee and are considered in the withholding obligation for purposes of determining the federal withholding deposit due date. (IRS Reg. Section 1.451-2(a).)

Under IRC Section 1341, when wage repayments occur in subsequent years, the claim of right rule applies. Under this rule, when a repayment is made, the adjustment to federal taxable wages applies in the year of the original payment. For instance, if a salary advance that is paid in 2023 is repaid in 2024, the adjustment to federal taxable wages applies in 2023 and not in 2024.

Further, under the claim of right doctrine, a taxpayer's right to a federal income tax credit for the wage repayment may be restricted based on the facts and circumstances. Accordingly, when issuing a Form W-2c to reflect the repayment of a wage advance, a reduction is allowed only to Social Security and Medicare taxable wages and taxes withheld and not to wages subject to federal income tax or federal income tax withheld. (SCA 1998-026; Publication 15, pg. 37; Revenue Ruling 79-311, 1979-2 CB 25.)

Under IRC Section 7872, the repayment of employer interest-free, below-market loans are not subject to the claim of right rule nor are they subject to federal income tax withholding if certain requirements are met.

Employers should review their EWA payments with an employment tax advisor to determine if they are compliant with the Maryland income tax withholding and reporting rules.

For more information on wage advances see our special report.

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Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor