Deceased employee W2 amendment created negative payroll liability – Help?

Addressing Payroll Challenges After the Loss of an Employee: Navigating W2 Amendments and Liabilities

The unfortunate passing of an employee can create unforeseen complexities within a company’s payroll system, especially when it involves tax documentation and liabilities. This scenario unfolded recently when one of the company owners passed away at the end of December 2023.

Although the employee was deceased, the company still issued a paycheck during the pay period that fell in 2024. This paycheck included deductions for a 401(k) loan payment and other regular withholdings. Subsequently, a W-2 was generated for this individual in January 2024, a practice that typically raises concerns, as it is generally inappropriate to issue tax documentation for a deceased individual.

Due to the timing of these events, I found myself in a challenging position. Having not been with the company when these actions were taken, I started the process of amending the W-2 and requested the payroll service to issue a 1099 to align with proper tax reporting requirements. Unfortunately, the W-2 amendment led to a journal entry (JE) from the payroll service which resulted in a negative balance in both the loan and withholding liability accounts.

In a more streamlined scenario, the company would typically refund any amounts back to the estate. However, due to the time elapsed between the employee’s passing and the estate’s tax filings, the funds from the employee’s 401(k) accounts had already been transferred, complicating the situation further.

Now, the pressing question is: how can we rectify the negative liabilities left on the books?

One potential solution could involve creating a journal entry to reallocate those amounts from payroll liabilities to payroll expenses. This approach may help in managing the negative balances currently displayed in your accounts. However, it’s essential to consider the implications this move will have on your balance sheet.

While this adjustment may relieve some short-term discrepancies by eliminating the negative liability, it will also reflect as an expense on your financial reports. This means your expenses will appear inflated, potentially impacting your net income for the Accounting period. Careful documentation and an understanding of the long-term effects on financial statements are crucial before implementing any changes.

In summary, navigating payroll issues following an employee’s demise requires careful consideration and prompt action. Consult with a financial advisor or accountant to explore the best options for amending your financial records while ensuring compliance with Accounting standards.