Navigating Payroll Challenges After an Employee’s Passing: A Case Study

Handling payroll and tax matters can be particularly complex under unfortunate circumstances, such as the passing of an employee. Recently, a unique situation arose involving the posthumous payroll processing of a company co-owner, shedding light on potential pitfalls and necessary corrections in payroll Accounting.

The Background

In late December 2023, one of the owners of a company passed away. The final payday for the associated pay period fell in 2024, resulting in a paycheck being issued to the deceased employee. This paycheck included standard deductions, such as a 401(k) loan repayment, and subsequently, a W-2 form was generated at the end of January 2024. It has come to light that providing a W-2 for a deceased individual is not compliant with IRS regulations.

The Fallout

As the individual in charge of payroll at the time of these events, the challenge presented itself when the estate solicited the filing of the late employee’s tax returns. This required the payroll service to amend the W-2 and issue a 1099 instead. However, this amendment created a journal entry (JE) from the payroll service, resulting in negative liabilities in the accounts related to both loan repayments and tax withholdings.

Given the extensive time that had passed since the employee’s death, the estate had already transferred funds from the employee’s 401(k) accounts due to the timing of the tax filings. Consequently, the expected refunds that should have been processed for these liabilities became impossible.

Finding a Solution

The question arises: how can one resolve this financial conundrum?

One potential solution involves making a journal entry to transfer the amounts from the payroll liability accounts into payroll expenses. But what implications might this have for the overall balance sheet?

Considerations for Resolution

1. Understanding the Effects: When moving the amounts to payroll expenses, it effectively clears the negative liabilities off the balance sheet. However, this action will also impact the income statement, as it will increase expenses, thus potentially reducing net income for the period.

2. Documenting Changes: Ensure that all adjustments are well-documented to maintain transparency and facilitate future audits. Clear records will also support any queries from tax authorities regarding the handling of the deceased employee’s payroll.

3. Consulting Professionals: Given the complexities involved, especially regarding tax compliance, it may be beneficial to consult with a CPA or financial advisor