Deceased employee W2 amendment created negative payroll liability – Help?

Addressing Payroll Complications Following a Deceased Employee’s W-2 Amendment

Handling payroll issues for a deceased employee can be a challenging endeavor, particularly in light of complex legal and tax considerations. Recently, a situation arose that many businesses may face: managing the financial implications following the passing of an employee.

At the end of December 2023, the unfortunate passing of one of our company owners marked the beginning of a convoluted payroll issue. Although the employee passed away in 2023, the final paycheck was processed in 2024, which included deductions for a 401(k) loan and other regular withholdings. A W-2 was subsequently issued at the end of January 2024, a practice that is not permitted for deceased individuals.

As someone who was not part of the team during these events, I found myself needing to address the situation when it came to filing taxes for the estate. I worked with our payroll service to amend the W-2, resulting in the issuance of a 1099 instead, aligning with appropriate tax practices.

However, this amendment led to a journal entry (JE) from our payroll service that introduced a negative liability into both the loan and withholding liability accounts. The smooth resolution typically involves refunding amounts to the estate. Yet, given the timing of the events—the delay between the employee’s death and tax filing—the estate had already transferred funds from the decedent’s 401(k) into another account. Consequently, the deductions for loan payments and withholdings could not be processed as intended.

So, what steps can be taken to rectify this situation? The resolution may be as straightforward as making a journal entry to move those negative amounts from the payroll liabilities to payroll expenses. However, it’s essential to consider the broader implications of this adjustment.

Shifting these amounts will clear the negative liability from our accounts, but it will also impact the balance sheet. Specifically, transferring these amounts to payroll expenses would increase our expense line, potentially affecting profitability metrics for that Accounting period. It’s important to communicate with any stakeholders and ensure that this adjustment is well-documented to maintain transparency and accuracy in financial reporting.

In conclusion, while addressing payroll after the loss of an employee can be complicated, understanding the necessary adjustments and their implications will aid in restoring proper financial order within the organization. Always consult with a financial expert or legal advisor to ensure compliance with regulations during such sensitive circumstances.