Navigating Payroll Challenges After the Loss of an Employee: A Case Study

When an employee passes away, it can create unexpected complications for a business, especially when it comes to payroll and tax reporting. A recent scenario brought to light some of these challenges, particularly surrounding the issuance of a W-2 and the subsequent liabilities that arise.

Background of the Situation

In this particular case, the unfortunate passing of a company owner occurred at the end of December 2023. Payroll for that period was processed in January 2024, during which a paycheck was issued, complete with deductions for a 401(k) loan payment and regular withholdings. At the end of January, when W-2s were generated, it became apparent that issuing a W-2 for a deceased employee is typically not permissible.

As the author was not part of the team during these events, they found themselves in the position of needing to amend the deceased employee’s W-2 for the purposes of filing taxes for the estate. This amendment required the involvement of a payroll service provider, which then inadvertently led to the creation of journal entries that resulted in a negative balance in both loan and withholding liability accounts.

The Core Issue

The crux of the problem arises from the timing of events. Given the delay between the employee’s passing and the tax filings, the estate proceeded to shift funds from the deceased’s 401(k) accounts into a different account, effectively moving the loan payments and regular withholdings as well. This has left the current books showing negative liabilities, raising the question of how to resolve the issue.

Finding a Solution

To rectify this situation, the initial consideration is whether a simple journal entry (JE) can be made to move those negative amounts from the payroll liabilities to payroll expenses.

Impact on Financial Statements

This approach would indeed clear out the negative liabilities, but it is essential to understand the broader implications for the balance sheet. By reclassifying these amounts as payroll expenses, you would be adjusting the financials to reflect a more accurate status post-amendment. However, this action could also affect profit margins, and proper documentation will be necessary to ensure transparency during any financial reviews.

Conclusion

Addressing payroll issues surrounding a deceased employee can be complex and must be handled with care to avoid further complications. If faced with a similar situation, it is prudent to consult with a financial advisor or a payroll professional to navigate the specifics and ensure compliance with legal requirements.