Deceased employee W2 amendment created negative payroll liability – Help?

Managing Payroll Liabilities Following the Loss of an Employee: Navigating Amendments and Adjustments

Losing an employee is never easy, and the complexities increase significantly when it comes to payroll management and tax filings. Recently, I encountered a unique situation involving a deceased employee and subsequent payroll amendments that resulted in some significant Accounting challenges.

At the end of December 2023, one of our company owners sadly passed away. However, a payday occurring shortly after his passing, in early 2024, led to the issuance of a paycheck for that final pay period. This paycheck included deductions for a 401(k) loan and routine tax withholdings. Compounding the issue, a W-2 form was generated at the end of January 2024 for the deceased, which has since been brought to my attention as improper since W-2s should not be issued for individuals who have passed away.

As I was not part of the organization at the time these events transpired, I had to take the initiative to contact our payroll service to request an amendment to the W-2 and issue a 1099 instead. This amendment created an unexpected journal entry (JE) from our payroll provider, resulting in a negative liability appearing in our loan and withholding liability accounts.

In typical scenarios involving such amendments, it’s common practice for the business to refund the amounts to the deceased employee’s estate. However, due to the considerable time that elapsed from the employee’s passing to the tax filings, the estate has since transferred the funds from the employee’s 401(k) accounts to another account. Consequently, both the loan payment and tax withholdings have also been moved, complicating the refund process.

Now, I’m left to determine how best to rectify this situation. My initial thought is that it may be as straightforward as creating a journal entry to reallocate those amounts from payroll liabilities to payroll expenses. However, I am keen to understand the implications this adjustment may have on our balance sheet, especially aside from addressing the negative liability.

If you have experience with similar circumstances or insights on how to navigate this matter effectively, please share your thoughts and advice. Your expertise could be invaluable as I work to resolve this complex issue.