Addressing Payroll Liabilities After the Loss of an Employee

The unfortunate passing of a valued employee poses unique challenges for a company, particularly when it comes to managing payroll and tax obligations. Recently, a situation arose involving a deceased employee, presenting some complex issues regarding W-2 forms and payroll liabilities.

At the end of December 2023, one of the company’s owners passed away. Although the individual was deceased, they were issued a paycheck during the pay period ending in 2024, which included deductions for a 401(k) loan and other withholdings. Complicating matters further, the payroll service generated a W-2 for the deceased in January 2024—a practice that is generally advised against when it comes to deceased individuals.

As the new hire responsible for handling this situation, I discovered that amendments to the W-2 were necessary for the estate’s 2023 tax filing. In response, I coordinated with the payroll service to amend the W-2 and issued a 1099. However, this amendment resulted in an unexpected journal entry from the payroll service, leading to a negative balance in the loan and withholding liability accounts.

Typically, under more timely conditions, such liabilities would be refunded to the estate. Unfortunately, due to the delay between the employee’s passing and tax filing, the estate had already transferred funds from the deceased’s 401(k) accounts, which included the loan payments and the standard withholdings.

This raises the critical question: how do I rectify this situation?

One potential solution appears to be making a journal entry to shift these amounts from the payroll liabilities to payroll expenses. However, it’s essential to consider the implications this may have on the company’s financial statements, specifically the balance sheet. While this action may resolve the negative liability, it could also affect the overall financial health of the company.

If you’ve faced a similar situation or have insights into managing payroll liabilities in such circumstances, your input would be greatly appreciated. It’s vital for all businesses to navigate these challenging waters appropriately while remaining compliant with tax regulations.