Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Challenges After the Passing of an Employee

Dealing with the passing of an employee is a difficult situation for any business, especially when it comes to managing payroll and tax obligations. Recently, our company faced an unexpected challenge related to the winding down of payroll processes for a deceased team member.

At the end of December 2023, one of the company’s owners sadly passed away. Payday for that pay period was observed in January 2024, leading to a paycheck being issued that included deductions for both a 401(k) loan payment and standard withholdings. However, complications arose when a W-2 was generated for this individual at the end of January 2024, a practice that, as I later learned, is generally not permitted for employees who are deceased.

Having not been present during this occurrence, I found myself tasked with addressing the ramifications when the estate filed the deceased’s taxes. The payroll service was asked to amend the W-2 and issue a 1099 instead. However, this amendment inadvertently triggered a journal entry (JE) from the payroll service that left our Accounting records with negative balances in both our loan and withholding liability accounts.

Under normal circumstances, a refund of these amounts would be issued to the estate. However, due to the lengthy delay between the employee’s passing and the tax filing, the estate had already transferred the deceased’s funds from their 401(k) accounts to another account, which also included the loan payment and regular withholdings.

This has left me with the pressing question: how do we resolve this negative liability situation?

Is the solution as straightforward as creating a journal entry to shift those amounts from payroll liabilities to payroll expenses? If so, what impact will this adjustment have on our balance sheet, aside from rectifying the negative liability?

Navigating these types of Accounting challenges can be complex and may require insights from both payroll experts and Accounting professionals to ensure our financial records remain accurate and compliant. If you’ve faced similar situations or have expertise in handling such matters, your guidance would be immensely valuable. Let’s work together to find the best path forward in resolving this issue.