Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Complications Amidst a Tragic Loss: Addressing a Deceased Employee’s Tax Liabilities

The unfortunate passing of a key employee can present complicated challenges for any business, especially in the realm of payroll and taxation. For instance, following the death of one of our company owners at the end of December 2023, we encountered significant issues related to payroll processing and tax documentation that required immediate attention.

Upon his passing, a paycheck was issued during the subsequent payday in 2024, which included deductions for a 401k loan and other regular withholdings. Additionally, a W2 form was erroneously generated at the end of January 2024. However, according to IRS regulations, it is generally prohibited to issue a W2 to a deceased employee. This was a complication that arose during a period when I was not yet part of the team, and it necessitated corrective measures as the estate’s tax filings came into play.

To rectify the situation, I coordinated with our payroll service provider to amend the W2 and instead issue a 1099 to the estate. Unfortunately, this amendment led to a journal entry from our payroll service that has resulted in a negative liability reflected in our loan and withholding accounts—a scenario that complicates our financial standing.

It is crucial to understand that ordinarily, under faster circumstances, the business would issue a refund to the estate for the erroneous withholdings. However, due to the delay between the employee’s death and the estate filing taxes, the funds had already been transferred from the employee’s 401k into other accounts, complicating the situation further.

Now, I am faced with the daunting task of resolving this negative payroll liability. One potential solution could involve creating a journal entry to reallocate those amounts from payroll liabilities to payroll expenses. While this could effectively eliminate the negative liability, it raises additional questions about the implications for our balance sheet. Specifically, I need clarity on how this adjustment will impact our financial statements beyond simply resolving the liability imbalance.

If you’ve encountered similar issues or have expertise in payroll and Accounting matters post-employee death, your insights would be invaluable. Navigating these situations can be tricky, but with the right approach, we can ensure compliance while maintaining the integrity of our accounts.