Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Liabilities After the Loss of an Employee: A Case Study

In the complex world of payroll management, unfortunate events can lead to unexpected complications. A recent situation involving the passing of a company owner highlighted some of the intricacies that can arise, particularly regarding tax filings and payroll liabilities.

The Situation

At the close of December 2023, one of the company’s owners passed away. During the subsequent payroll cycle in early 2024, a paycheck was processed for this individual, which included deductions for a 401(k) loan payment as well as other regular deductions. By the end of January 2024, a W-2 form was issued for this individual, sparking questions about the appropriateness of such a practice posthumously.

The emerging problem stems from the realization that issuing a W-2 for a deceased employee may not be permissible according to IRS guidelines. Since I was not part of the organization during this time, I had to rely on the payroll service to amend the W-2 and issue a 1099 when the estate’s taxes were being filed.

The Complication

Upon requesting the amendment, the payroll service created a journal entry (JE) that resulted in negative liabilities on the loan and withholding accounts. Ordinarily, when handling a deceased employee’s finances, the company would refund any payroll liabilities to the estate. However, due to the significant lapse of time between the owner’s death and the tax filing, the estate had already reallocated funds from the employee’s 401(k), impacting the original loan payment and withholding deductions as well.

Seeking Solutions

Now, the challenge is how to resolve the negative liability issues on the balance sheet. Is it enough to make a journal entry to transfer these amounts from payroll liabilities to payroll expenses? If so, what impact will this have on the financial statements beyond alleviating the negative balances?

Steps to Consider

1. Clean Up the Books: Creating a journal entry to adjust payroll liabilities could be a straightforward approach to rid the balance sheet of negative amounts. This adjustment would help ensure that the financial statements present a more accurate picture of the company’s liabilities.

2. Understand Financial Implications: While shifting these amounts to payroll expenses may eliminate negative liabilities, it’s essential to consider the impact on profit margins and tax implications. Proper classification in Bookkeeping is vital for accurate financial reporting. Consult with a financial advisor if needed.

3. Consult with Payroll Professionals: Reach out to