Navigating Payroll Challenges Following the Death of an Employee

The unfortunate reality of losing a team member can lead to complicated financial situations, especially in the context of payroll and tax filings. A recent case highlights these challenges, involving the handling of W-2 forms and outstanding payroll liabilities.

In late December 2023, the company faced the tragic passing of one of its owners. The situation became significantly more complex when the payday for that particular period fell in January 2024, inadvertently resulting in the issuance of a paycheck for the deceased. This paycheck included deductions for a 401(k) loan payment and standard withholdings. To compound the issue, a W-2 was generated at the end of January 2024—an action generally considered impermissible for a deceased employee.

As I was not part of the organization at that time, I found myself navigating this intricate scenario when the estate began filing the late employee’s 2023 taxes. To comply with regulations, I had to request that our payroll service adjust the W-2 and issue a 1099 in its place. However, this W-2 amendment subsequently generated a journal entry (JE) from the payroll service, resulting in negative balances within the loan and withholding liability accounts.

Ordinarily, it’s expected that a business would refund these amounts to the estate. Unfortunately, due to the time elapsed between the employee’s passing and the tax filings, the estate had already transferred funds from the employee’s 401(k) accounts elsewhere, taking the loan payment and withholding adjustments with them.

So, how do we address this financial predicament?

The first step might involve creating a journal entry to shift these amounts from payroll liabilities to payroll expenses. However, it’s crucial to understand the implications of this adjustment on the balance sheet. Primarily, this move would eliminate the negative liabilities and potentially impact our financial statements, including altering asset allocation and expense reporting.

Navigating payroll matters after an employee’s death can be daunting, but understanding the necessary adjustments and their consequences is pivotal in rectifying such situations. Seeking guidance from an accountant or a payroll specialist can also provide additional support and clarity, ensuring that these errors are managed appropriately while maintaining compliance with financial regulations.

Do you have experience in managing similar payroll challenges or insights on best practices? Your thoughts may help others tackling the same issues.