Navigating Payroll Complications Following the Passing of an Employee

The world of payroll can be complex, especially in unfortunate circumstances like the passing of an employee. Recently, I encountered a perplexing issue concerning the final compensation of a deceased employee that has created a ripple effect within our financial records. I hope that by sharing my experience, others might find guidance in similar situations.

At the end of December 2023, our company faced the sudden loss of one of its owners. As we attempted to manage the aftermath, we were faced with a complication regarding the final payday that fell in the following year, 2024. During this pay period, the deceased was issued a paycheck, which included deductions for a 401(k) loan payment and regular withholdings. Subsequently, a W-2 form was generated at the end of January 2024, despite it being common knowledge that this practice is typically not permitted for individuals who have passed away.

Since I was not on board at the time of the incident, the responsibility of rectifying this situation fell to me when the estate began the process of filing taxes for 2023. I promptly reached out to our payroll service provider to request an amendment of the W-2 and to issue a 1099 instead, adhering to compliance standards.

However, this amendment resulted in a journal entry (JE) from our payroll service, leaving a negative balance in both the loan liability and withholding accounts. It’s my understanding that typically, under more immediate circumstances, a business would refund any overpayments to the estate. Unfortunately, due to the passage of time, the estate has already relocated funds from the deceased’s 401(k) plan, which included the amounts related to the loan payment and standard withholdings.

Now, I find myself at a crossroads, seeking advice on how to remedy this financial discrepancy. My question is whether creating a journal entry to transfer these amounts from payroll liabilities to payroll expenses would be the appropriate step. Additionally, I am curious about the implications of this adjustment on our balance sheet — aside from resolving the negative liability, what other effects might it induce?

If anyone has navigated similar waters or has expertise in handling payroll issues involving deceased employees, your insights would be invaluable. Thank you for any guidance you might provide as we work through this challenging situation.