Navigating Payroll Complications After an Employee’s Death

Dealing with the loss of an employee is challenging, both emotionally and administratively. However, the complexities can multiply when it involves payroll and tax implications, as one business owner recently discovered following the tragic death of a colleague.

The Scenario

Tragically, a company owner passed away in late December 2023. The pay period concluding in December led to a paycheck being issued in January 2024 — a situation that can become problematic, especially regarding tax documentation. This paycheck included deductions for a 401(k) loan and standard withholdings, followed by the issuance of a W-2 in January 2024. However, a critical error was made: a W-2 should not be generated for an individual who has passed away.

As a result, when the estate began filing taxes for 2023, an amendment was necessary. This prompted a request to the payroll service provider to revise his W-2 to issue a 1099 form instead. Unfortunately, this amendment sparked a journal entry from the payroll service that resulted in a negative liability showing in both the loan and withholding accounts.

Delay Compounds Complexity

The complexity of this situation was exacerbated by the gap between the employee’s death and the estate’s tax filing. During this interval, funds from the employee’s 401(k) accounts were relocated to another account, thereby impacting the original deductions that had been made from his paycheck.

Seeking Solutions

Now, the question arises: how can one rectify this negative liability issue? The initial assessment is whether a journal entry (JE) can transfer amounts from payroll liabilities to payroll expenses. While this may seem like a straightforward solution to clear the negative liability, it raises another set of questions about its effects on the balance sheet and overall financial reporting.

Next Steps

1. Consult a Professional: Before making any journal entries or adjustments, it is vital to consult with a CPA or a tax professional. They can provide tailored advice and ensure compliance with applicable tax laws.

2. Document Everything: Keep comprehensive records of all transactions related to the deceased employee, including correspondences with the payroll service and any steps taken to amend tax filings.

3. Adjusting Financial Statements: If a journal entry is deemed appropriate, understand its implications fully. Moving amounts from liabilities to expenses may clear the negative balance but could alter your profit and loss statement.

4. **Communicate with the Payroll Service