Navigating Payroll Challenges Following the Passing of an Employee: A Case Study

Dealing with payroll matters is already a complex task for many businesses, but when complications arise following the unexpected passing of an employee, it can lead to additional challenges. Recently, a case came to light involving the management of payroll liabilities after the death of an employee, highlighting some crucial considerations for employers.

The Situation Unraveled

In December 2023, one of the company’s owners passed away. However, payday for that particular pay period occurred in 2024, which led to the issuance of a paycheck that included deductions for a 401(k) loan and various regular deductions. At the end of January 2024, the company issued a W-2 for the deceased employee. This step raised flagging concerns, as it is generally not permissible to issue a W-2 for an individual who has passed away.

When the estate began preparing the 2023 tax filings, it became necessary to request that the payroll service amend the W-2 and instead issue a 1099. This amendment triggered a journal entry (JE) from the payroll service that resulted in a negative balance in the loan and withholding liability accounts.

The Complications of Delayed Actions

Typically, one might expect that a business would refund any overpaid amounts back to the estate in a timely manner. However, in this case, a considerable amount of time had elapsed between the employee’s passing and the tax filing. The estate subsequently transferred funds from the employee’s 401(k) accounts, which included the loan payment and routine withholding deductions. This scenario has left lingering questions about how to rectify the negative liabilities created from the W-2 amendment.

Seeking a Solution

The primary dilemma now is determining the most appropriate way to address these negative payroll liabilities. One possible approach could be to create a journal entry that shifts these amounts from payroll liabilities to payroll expenses.

But what implications would this adjustment carry?

Clearing the negative liability would be an immediate benefit, but it’s essential to consider the broader impact on the balance sheet. Moving amounts from liabilities to expenses could affect the overall financial picture of the business, including net income and retained earnings.

Conclusion

In conclusion, this case serves as a reminder of the complexities involved when an employee passes away, particularly regarding payroll processing and tax implications. Employers should stay informed about best practices during such sensitive times and ensure timely communication with payroll services to prevent negative balances. Eng