Resolving Payroll Liability Issues After the Passing of an Employee

The unfortunate loss of an employee can bring a host of challenges for business owners and their financial teams, particularly regarding payroll operations and tax filings. A recent situation experienced by a business owner serves as an illuminating case study on how to handle payroll liabilities and amend tax records following the death of an employee.

In this scenario, a company lost one of its owners at the close of December 2023. Due to payroll processing, this individual received a paycheck during the first payday of 2024, which included deductions for a 401(k) loan and regular withholdings. At the end of January 2024, a W-2 form was issued for this individual, but complications arose because it is generally not permissible to issue such tax forms for deceased employees.

Since the person managing payroll during that period was not present at the company when these events transpired, they were tasked with amending the W-2 and providing a 1099 to assist the estate in addressing tax obligations. However, this amendment led to a journal entry (JE) from the payroll service that resulted in a negative liability in the accounts for both loan and withholding deductions.

The individual soon discovered that under normal circumstances, a business would typically refund any overpayment related to these liabilities back to the estate. Unfortunately, due to the time lapse between the employee’s passing and tax filings, the estate had already transferred funds from the deceased’s 401(k) into a different account, further complicating the situation.

The key question arises: how can this issue be rectified? Is there a straightforward method to clear the negative payroll liabilities left in the accounts?

Steps Toward Resolution

To resolve this issue, a simple journal entry could potentially transfer the amounts from the payroll liabilities to payroll expenses. Doing this could effectively eliminate the negative liability, but it also raises additional questions about the impact on the balance sheet.

Considerations for Moving Forward:
1. Accounting Adjustments: By transferring amounts from liabilities to expenses, you would clear the negative positions but increase your expenses accordingly. This can influence your profit loss statement, so careful consideration is necessary.

1. Documentation: Ensure that all changes are well-documented. This includes maintaining records of communications with the payroll service and the estate handling. Proper documentation aids in complying with potential audits.

2. Consulting Experts: Engaging a CPA or a tax advisor familiar with payroll and estate tax issues can