Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Liabilities After the Loss of an Employee: A Guide

The passing of an employee is a challenging time for any organization, and navigating the subsequent financial obligations can be equally complex. In a recent case involving the estate of a deceased employee, several critical issues arose regarding payroll, tax documentation, and liabilities that warrant discussion.

The Situation at Hand

In December 2023, one of the company’s owners tragically passed away. The timing of this event posed complications as the payday for that particular pay period fell in the subsequent year, 2024. The late employee was issued a paycheck that included deductions for a 401k loan and other standard withholdings. However, a W-2 was also issued at the end of January 2024, which raises questions about compliance, as it is generally against regulations to issue a W-2 for a deceased individual.

As the employer was not present during these transactions, it became necessary to amend the W-2 and issue a 1099 for the deceased during the estate’s tax filing process. This situation resulted in a journal entry from the payroll service that inadvertently created a negative liability in the accounts related to loans and withholdings.

Understanding the Consequences

In typical circumstances, any funds withheld from a deceased employee’s paycheck would ideally be refunded to the estate. However, given the time elapsed since the employee’s passing and the subsequent handling of their 401k funds, much of the amount has already been transferred elsewhere, complicating the refund process.

Now, the challenge lies in addressing the negative liabilities generated by the W-2 amendment.

Finding a Solution

One potential remedy for this issue is to prepare a journal entry (JE) that reallocates the negative amounts from payroll liabilities to payroll expenses. While this action may seem straightforward, it’s essential to consider its implications on the balance sheet.

By moving these amounts to payroll expenses, you may eliminate the negative liabilities, but it will simultaneously affect the overall financial reporting. This adjustment will increase your expense line, thereby reducing net income for the reporting period.

Steps to Take

1. Review Documentation: Ensure all payroll records, W-2, and 1099 forms are accurate and reflect the necessary amendments.
2. Communicate with Payroll Service: Engage with your payroll service company to clarify past transactions and confirm the best path forward.
3. Adjust Journal Entries: Prepare the journal entry to move amounts