Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Challenges After the Loss of an Employee

The passing of an employee often brings about challenges that extend beyond emotional losses; financial and administrative complications can arise too. Recently, a company encountered a particularly complex situation involving payroll and tax filing after the death of one of its owners. This case serves as a poignant reminder of the intricacies involved in managing employee compensation and tax obligations, especially in unforeseen circumstances.

The Background

In December 2023, one of the company’s owners passed away, and, unfortunately, the final paycheck issued fell into the following calendar year, January 2024. This paycheck included deductions for a 401(k) loan and regular payroll withholdings. At the end of January 2024, a W-2 was issued for the deceased employee, which sparked confusion regarding its legality, as it is generally not permissible to issue tax forms for deceased individuals.

As the new employee responsible for handling payroll and taxes, I had to take the initiative to rectify this situation. I requested that our payroll service amend the W-2 and, instead, issue a 1099 for the deceased employee, aligning with appropriate tax practices. However, this amendment led to a journal entry (JE) from the payroll service that resulted in a negative liability within our loan and withholding accounts, complicating matters further.

Understanding the Implications

In a timely situation, typically, the business would refund those amounts to the estate, thus resolving any outstanding liabilities. However, due to the elapsed time between the owner’s death and the tax filing, the estate had already moved funds from the deceased’s 401(k) accounts into another account, which included both the loan payment and regular withholdings. This has left the company in a bit of a financial quandary—how do we correct this negative balance?

Steps to Resolve the Issue

To address this, one potential solution is to make a journal entry that reallocates amounts from payroll liabilities to payroll expenses. It’s crucial to consider how this adjustment will impact the overall financial statements. Clearing out the negative liability will certainly simplify our accounts, but it may also affect our balance sheet by altering our total liabilities and expenses.

Key Considerations

1. Consult a Professional: Before making any entries, it may be wise to consult a financial professional or tax advisor. They can provide insight specific to our situation and ensure compliance with IRS regulations.

2. Documentation: Maintain meticulous records of all communications with the payroll