Deceased employee W2 amendment created negative payroll liability – Help?

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

When an employee passes away, especially towards the end of the year, it can create unexpected challenges for a company’s payroll and tax processing. This situation recently arose at a business where a long-time owner died in December 2023. Unfortunately, the payroll for the final pay period issued in 2024 included deductions for a 401(k) loan and standard withholdings, leading to complications with tax documents.

Despite the employee’s passing, a W-2 form was generated at the end of January 2024, a practice not typically allowed for deceased individuals. The oversight was realized too late, prompting the need for an amendment to the W-2, which resulted in the necessity of issuing a 1099 statement for tax purposes.

One of the primary concerns raised by handling this unfortunate situation is the subsequent impact on payroll liabilities. The amendment from the payroll service created an unexpected journal entry (JE) that resulted in negative balances in both the loan and withholding liability accounts.

In a typical scenario where timing is on their side, businesses would refund the pertinent amounts to the estate. However, due to the elapsed time between the employee’s death and tax filings, the funds associated with the deceased employee’s 401(k) have already been relocated, along with the associated loan payments and withholdings.

Addressing Payroll Liability Issues

So, how does a business rectify this situation? One potential solution could be creating a journal entry to transfer these amounts from payroll liabilities to payroll expenses. This action would effectively eliminate the negative liabilities on the balance sheet. But it raises questions about broader implications.

What to Consider When Making Adjustments

1. Impact on Financial Statements: While moving liabilities to expenses may resolve the immediate issue of negative balances, consider how this will affect your company’s overall financial health and reporting.

2. Consult with a Professional: Engaging with a tax advisor or accountant is critical. They can provide guidance based on specific regulations and ensure compliance with IRS requirements during such unique circumstances.

3. Documentation: Maintaining clear records of the adjustments made will be essential for future reference, particularly if the deceased employee’s estate or IRS inquiries arise.

4. Review Policies: This unfortunate event may serve as an opportunity for your organization to revisit its payroll procedures, especially regarding handling payroll for employees who pass away during a pay period.

Navigating the complexities of payroll liabilities after an employee