Navigating Payroll Challenges After the Loss of an Employee: A Guide for Business Owners

The unexpected loss of an employee always brings emotional and operational challenges to a business. If you’ve recently experienced the passing of a team member, you may find yourself grappling with complex payroll issues, such as correcting tax documents and managing liabilities that arise from this sad event.

A Case Study in Payroll Adjustments

In December 2023, a valued member of our company passed away. Unfortunately, the timing coincided with our payroll cycle, leading to a paycheck being issued in 2024, which included deductions for a 401(k) loan and regular withholdings. To complicate matters further, by the end of January 2024, a W2 was generated for this individual—an occurrence that is generally not permissible for deceased employees.

As someone who wasn’t part of the team at the time of these events, I found myself stepping in during the estate’s tax filing process. To comply with legal requirements, I reached out to our payroll service provider and requested an amendment to the W2, subsequently needing to issue a 1099 instead.

The amendment process, however, sparked a cascade of entries in our Accounting system, resulting in negative liabilities in both the loan and withholding accounts. Ordinarily, the next step would involve refunding those amounts to the deceased’s estate. However, due to the significant time lapse between the employee’s passing and the tax proceeding, the estate had already transferred the funds from the employee’s 401(k) to another account, further complicating our liabilities.

Seeking a Resolution

Now, the question remains: how can we resolve this financial tangle? Is it as straightforward as adjusting entries to transfer amounts from payroll liabilities to payroll expenses? If so, what consequences would this maneuver have on our balance sheet—beyond merely balancing out the negative liability?

Steps to Consider

1. Review Payroll Records: Begin by confirming all records related to the deceased employee’s payroll, including the final paycheck and any deductions.

2. Consult with the Payroll Service Provider: Engage with your payroll service to understand how they have handled the amendment and if any additional adjustments are needed.

3. Make Necessary Journal Entries: If you decide that moving negative liabilities to payroll expenses is appropriate, ensure that these entries are correctly documented. This could indeed clear out negative balances but be aware of how it may impact your overall financial statements.

4. **Communicate with