Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Challenges After the Passing of an Employee

When managing payroll, businesses sometimes encounter unique challenges that can arise from unexpected events. A recent situation involving the unfortunate passing of a company owner highlights some of these challenges, specifically regarding the handling of payroll liabilities and W2 amendments.

In late December 2023, a valued owner of the company passed away, with the final pay period extending into 2024. During this period, he received a paycheck from which deductions for his 401(k) loan and regular contributions were subtracted. However, complications arose when the payroll service issued a W2 for the deceased employee at the end of January 2024—an action generally deemed inappropriate as it pertains to reporting for someone who has passed.

As I was not part of the company during these transactions, I faced the challenge of addressing the deceased’s tax obligations once the estate began filing 2023 returns. To rectify the situation, I reached out to the payroll service provider to amend the original W2, requesting the issuance of a 1099 instead.

This amendment led to the generation of a journal entry (JE) from the payroll service, resulting in negative balances within the loan and withholding liability accounts. Under normal circumstances, the business would typically refund these amounts back to the estate. However, due to the time elapsed between the employee’s passing and the tax filings, the estate had already transferred funds out of the deceased’s 401(k) account, complicating matters further.

So, how does one address this dilemma?

One potential solution is to create a journal entry to transfer the negative amounts from the payroll liabilities to payroll expenses. It’s essential to consider the implications of this adjustment on the balance sheet. While it may effectively clear the negative liability, this reallocation means that those amounts will begin to affect the income statement as expenses, rather than being categorized as liabilities.

It’s advisable to consult with your Accounting team to ensure compliance and proper financial reporting moving forward. Dealing with the aftermath of such sensitive situations requires careful attention to detail and a thorough understanding of payroll and tax regulations to maintain the integrity of your financial statements.