Deceased employee W2 amendment created negative payroll liability – Help?

Title: Navigating Payroll Liabilities After Employee’s Death: Seeking Solutions

Managing payroll can be a complex task, especially when unforeseen circumstances arise, such as the passing of an employee. Recently, I encountered a situation involving the untimely death of a company owner at the end of December 2023, which led to complications with the payroll and tax reporting for that individual.

During the payroll period following the owner’s death, a paycheck was issued in 2024, complete with deductions for a 401(k) loan payment and standard withholdings. As part of the year-end processes, a W-2 was generated for the deceased in January 2024, despite this being against IRS regulations for individuals who have passed away.

Since I was not part of the team at the time these transactions occurred, I faced some challenges when it came time to file the estate’s taxes for 2023. To rectify the initial error, I requested the payroll service company to amend the original W-2 and replace it with a 1099 form.

This amendment, however, created a journal entry from the payroll service, leading to a negative balance in the payroll liability accounts related to deductions and the outstanding 401(k) loan. Typically, one would expect the company to issue a refund for these amounts to the deceased’s estate in a timely manner. Unfortunately, by the time we identified the need for correction, the estate had already moved the funds from the employee’s 401(k) accounts, which complicates the situation further.

Now, I am seeking advice on how best to address this issue. Would it be sufficient to create a journal entry that transfers the negative amounts from the payroll liabilities to payroll expenses? Additionally, I’d like to understand what implication this might have for my balance sheet beyond resolving the negative liability.

Conclusion

Navigating payroll liabilities after an employee’s death can be an intricate process filled with regulatory requirements and potential headaches. It is crucial to act diligently yet thoughtfully to ensure accurate records and compliance. If anyone has insights or experiences in handling similar situations, your guidance would be greatly appreciated as I work toward a solution.