Uncashed Payroll Checks: Handle With Care

Small business owners may have the best of intentions when, instead of cashing their paychecks, they let them stack up in a drawer. If cash flow is tight, the owner may see this as a way to ease the crunch. That strategy may work on a short-term basis, but suppose the owner unexpectedly dies? Depending on the circumstances, those checks might become part of a probate claim.That was the situation several years ago when the Wisconsin Supreme Court faced a claim filed by a Wisconsin liquor store owner against his father's estate over uncashed payroll checks.(Edward N. Gerczak Jr. v. Estate of Edward N. Gerczak Sr., No. 2005-AP70-FT, 6/14/05)

Facts of the case

Edward Gerczak Jr. argued that his father, who owned the store until his death, sometimes intentionally failed to cash his own payroll checks when the business ran into cash flow problems. After Gerczak Sr. died, his son filed a claim with the estate seeking more than $164,000 that the son said represented his father's loans to the business. The loan was provided in the form of uncashed payroll checks.

The son argued that the checks amounted to loans. Under Wisconsin law, it gave him four years longer to file a claim than if the uncashed checks were deemed to be unpaid wages. However, the trial court found Gerczak Sr.'s uncashed payroll checks fell into the category of unpaid wages since the son couldn't produce any credible evidence that, by not cashing paychecks, his father intended to effectively create a loan to the business. The son sought to offer testimony from his wife -- who worked as the store's bookkeeper -- on the loan question, but the trial court ruled she couldn't testify because under Wisconsin law, she wasn't a credible witness in a probate case. Her status as a party with a "vested interest'' in the outcome of the case made it improper for her to testify, the judge ruled. The Wisconsin Supreme Court upheld the trial court's finding. The justices found that the wife's testimony was properly excluded. Without evidence that the uncashed paychecks were intended as loans, Gerczak Jr. couldn't prove his case. The court noted, however, that such checks might be considered loans to a business if a claimant has evidence that the employee intended them to fall into such a category.

The Point to Remember

Unclaimed property is becoming an increasingly important issue and in response, states are stepping up their audits of entities that handle such assets.

State auditors want to see that unclaimed checks receive proper treatment and that the employers' financial statements accurately reflect the liabilities. Employers cannot simply void or write off uncashed payroll checks.

While this particular ruling is applicable only to Wisconsin law, it does highlight the need for small business owners and corporate payroll managers to handle uncashed payroll checks with care. Such checks are a liability of a business that can generally only be extinguished when the employee or former employee cashes the check or the state takes it as "unclaimed property." In most states, state officials can't seize the money until after a set time period elapses -- a year, in many instances. Businesses are also still on the hook for any Social Security and state taxes on uncashed amounts, as well as Medicare withholding. Uncashed payroll checks can also become the subject of litigation, as in the Gerczak case. To avoid problems, its generally best to put the money into an escrow account that is subject to careful internal controls. If there's any doubt that your company or business has satisfied its obligations with regard to uncashed payroll checks, consult with your advisers for guidance.