Deceased employee W2 amendment created negative payroll liability – Help?

Title: Navigating Payroll Complications After the Death of an Employee

When a key employee passes away, the implications for payroll and Accounting can become confusing, as illustrated by a recent case within a company. In December 2023, one of the company’s owners sadly passed away, and this event triggered a series of Accounting challenges, particularly relating to an incorrect W-2 issuance.

In January 2024, during the processing of the estate’s taxes, a paycheck was inadvertently issued to the deceased individual. This paycheck included deductions for a 401(k) loan payment and other withholdings—actions that should have been halted due to the employee’s status. The completion of a W-2 for this individual raised questions, as it is generally not permissible to issue tax documents for a deceased employee.

Since the payroll team was not in place when these decisions were made, they faced the task of requesting an amendment from their payroll service provider. This amendment, while necessary for compliance, resulted in a journal entry (JE) that accidentally created negative balances in the liability accounts for both the loan and the withholdings.

Now, the business faces the dilemma of how to rectify these negative entries. Generally, such situations would allow for refunds to be processed back to the estate; however, significant time had passed since the employee’s passing, leading to complications with the 401(k) funds moving to a different account.

So, what’s the best way to address this liability issue?

Steps to Consider:

1. Evaluate the Situation: Understand that the W-2 amendment has resulted in a misalignment between expected liabilities and actual funds held.

2. Journal Entry Adjustment: A potential solution is adjusting the incorrect liabilities by creating a journal entry that reclassifies amounts from payroll liabilities to payroll expenses. However, it’s essential to proceed cautiously.

3. Impact on Financial Statements: Reclassifying amounts will undoubtedly clear the negative liability records; however, it will also affect your balance sheet. You’ll want to analyze how this will influence overall payroll expense reporting and whether adjustments are needed in your financial forecasts.

4. Consult an Accountant: Given the complexities involved, particularly with the tax ramifications and the implications for the estate, collaborating with a qualified accountant or tax advisor is highly recommended to ensure compliance and accuracy in your financial reporting.

5. Establish Protocols: To avoid future occurrences, consider establishing clear protocols for payroll processing in the event of