Deceased employee W2 amendment created negative payroll liability – Help?

Resolving Payroll Issues Following the Passing of an Employee: A Case Study

Navigating payroll complexities can become particularly challenging in the unfortunate event of an employee’s passing. A situation involving a deceased employee’s tax documentation recently underscored the need for clarity in such sensitive matters. Here’s a detailed overview of the problems encountered and potential solutions when handling payroll liabilities related to an employee who has passed away.

The Background Story

At the close of December 2023, one of our company’s owners sadly passed away. Payday for the final pay period fell in January 2024, which led to the issuance of a paycheck. From this paycheck, customary deductions—including a 401(k) loan payment—were withheld, followed by the issuance of a W-2 form at the end of January 2024. I quickly learned that generating a W-2 for a deceased individual is not compliant with tax regulations.

As I was not part of the team during these events, I became involved only when the estate was preparing the deceased’s 2023 taxes. This is when it became necessary to ask our payroll service provider to amend the W-2 and issue a 1099 instead. However, the amendment process triggered a journal entry (JE) from the payroll service that resulted in a negative liability in the loan and withholding accounts.

Understanding the Implications

Typically, had the situation been addressed in a more timely fashion, our business would have refunded the relevant amounts back to the estate. Unfortunately, a significant delay occurred between the employee’s passing and the completion of the tax filing. As a consequence, the estate transferred the funds from the deceased employee’s 401(k) account into another account, effectively moving both the loan payment and usual withholdings.

Seeking Solutions

Now, the pressing question is how to rectify this negative liability issue. One potential approach involves creating a journal entry that reallocates these amounts from payroll liabilities to payroll expenses. However, it’s important to consider the wider implications of such an adjustment.

Impact on Financial Statements

Shifting these liabilities to payroll expenses would effectively clean up the negative liability issue from the balance sheet. However, this should be done with caution. While it may clear the immediate problem of the negative liability, it could also alter other financial metrics, such as overall expenses and profitability.

Conclusion

In summary, addressing payroll issues arising from the unfortunate passing of an employee requires careful consideration and a methodical approach. By reassessing and appropriately