Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Challenges After an Employee’s Passing: A Case Study

The loss of an employee is difficult for any organization, not just emotionally but also when it comes to navigating payroll and tax implications. Recently, a challenging situation arose for a company following the death of one of its owners at the close of December 2023. This case raises important questions about payroll processing when an employee passes away and how to properly amend tax documents afterward.

The Scenario Unfolds

In this instance, the employee had a paycheck issued in January 2024, after the end of the fiscal year. This paycheck included necessary deductions such as a 401(k) loan payment and other standard withholdings. However, a significant complication arose when it became clear that the issuance of a W-2 for a deceased individual is, in fact, prohibited. Unfortunately, the payroll service provider had already issued the W-2 at the end of January 2024.

Not knowing the specifics of this situation at the time, the current payroll administrator was left to navigate the aftermath. When it came time for the estate to file the deceased’s 2023 taxes, they were required to request the payroll service to amend the W-2 and instead issue a 1099 form, which is appropriate for taxable distributions posthumously.

The Resulting Financial Implications

As a consequence of this amendment, the payroll service generated a journal entry (JE) that introduced a negative liability within the loan and withholding accounts. Typically, if the situation were resolved promptly, the business would refund the relevant amounts to the deceased employee’s estate. However, due to the delay from death to tax filing, the estate had already transferred the funds from the employee’s 401(k) into another account. This development complicated the matter further, as the deductions for the loan payment and withholdings were also moved.

Seeking Solutions

Now, the question arises: how can we rectify these negative liability entries?

One possible solution is to create a journal entry that reallocates these amounts from payroll liabilities to payroll expenses. This adjustment would help clear out the negative liability noted on the balance sheet. However, it is crucial to consider the broader implications of such a move.

1. Impact on Financial Statements: Shifting from liabilities to expenses will decrease your payroll liabilities but will also increase your payroll expenses. This change can influence your overall financial position, particularly in how stakeholders view your company’s operating expenses on financial reports.