Deceased employee W2 amendment created negative payroll liability – Help?

Title: Navigating Payroll Complications After the Loss of an Employee: A Guide for Employers

In the unfortunate event of an employee’s passing, especially at the end of a fiscal year, employers can encounter unexpected complexities in their payroll management. A recent scenario involving a deceased employee illustrated this challenge, particularly with the issues surrounding W2 amendments and payroll liabilities.

The Situation

We recently faced a situation where one of our company’s owners passed away in late December 2023. As fate would have it, payday for that period occurred in January 2024, resulting in the issuance of a paycheck that included withholdings for a 401(k) loan payment and standard deductions. This seemed straightforward at the time—until a W2 was generated at the end of January 2024, which we later learned is not appropriate for an individual who has passed away.

As I was not present during these events, when the estate went to file the deceased’s taxes for 2023, I found it necessary to contact our payroll service provider. They were instructed to amend the W2 and issue a 1099 instead. However, this action triggered a journal entry from the payroll provider, resulting in a negative liability on our books in both the loan and withholding accounts.

The Complication

In typical circumstances, the next step would be to refund any amounts to the estate. However, time played a significant role here—the delay between the employee’s passing and the tax filing meant that funds from his 401(k) had already been reallocated to another account. Consequently, the related loan payment and standard withholdings had followed suit.

Now, we find ourselves seeking a resolution to this negative liability.

Finding a Solution

The question arises: How do we rectify this situation effectively? Is it as simple as adjusting the journal entries (JEs) to transfer those amounts from the payroll liabilities to payroll expenses? If so, what implications would this adjustment have on our balance sheet, other than eliminating the negative figures?

Next Steps

Correcting the payroll liabilities in this scenario is crucial not only for accurate financial reporting but also for maintaining compliance with tax regulations. Here’s a step-by-step approach to consider:

1. Consult with Financial Professionals: Before initiating any adjustments, it’s advisable to consult with your accountant or CPA. They can provide guidance specific to your situation and ensure compliance with IRS regulations.

2. Journal Entries Adjustment: If you receive the green light from a financial advisor