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

The unfortunate passing of a valued employee can lead to a complex array of issues for any business, particularly concerning payroll and tax filings. Recently, a situation arose that highlights the intricacies involved in managing an employee’s final paycheck and the associated tax documents.

In late December 2023, the owner of a company passed away. The timing of this event, coinciding with the payroll period, led to some complications. Although the employee had passed, a paycheck for that period was still issued in January 2024, including deductions for a 401(k) loan payment and other regular deductions. Additionally, a W-2 form was generated for the deceased, raising concerns about compliance with federal regulations regarding such situations.

As I was not part of the team during this event, I encountered these challenges while assisting with the estate’s tax filings for 2023. It became necessary to request an amendment to the W-2 from the payroll service company, transitioning the reporting from a W-2 to a 1099 form, as is appropriate for deceased individuals.

However, this amendment triggered a journal entry from the payroll company, resulting in a negative liability within the loan and withholding accounts. Typically, in a more timely manner, businesses refund such amounts back to the estate. Unfortunately, due to the delays between the employee’s death and the tax filing, the 401(k) funds had already been moved, complicating the refund process for the associated loan payments and withholdings.

Now comes the question: How can we resolve these negative liabilities?

One potential solution could involve creating a journal entry that reallocates these amounts from payroll liabilities to payroll expenses. However, this approach raises questions about its impact on the overall balance sheet. While this action may successfully eliminate the negative liability, it is essential to consider how it may affect financial statements and whether this aligns with Accounting standards.

If you’ve faced a similar situation or have insights into managing payroll liabilities posthumously, please share your experiences. Your expertise could prove invaluable to others navigating these challenging waters.