Resolving Payroll Liabilities After the Passing of an Employee: A Guide

The complexities of payroll management can multiply significantly in the event of an employee’s death, particularly when it comes to final paychecks and tax documentation. Recently, I encountered a unique situation involving a deceased employee that has left me navigating some challenging waters concerning payroll liabilities and tax implications. Here, I’ll share the details of the case and the steps I’m considering to rectify the issues at hand, in hopes of providing insights to others who might face similar circumstances.

The Context

In December 2023, one of the company owners passed away. Although passing away in one fiscal year, the individual’s paycheck was processed in 2024, which included deductions for a 401(k) loan and other withholdings. Subsequently, a W-2 was generated in January 2024 for the deceased employee, which has led to complications since it is typically not permissible to issue a W-2 for someone who has passed away.

As I was not part of the company when these transactions occurred, I had to request that our payroll service amend the W-2 to avoid legal repercussions and allow the estate to accurately file taxes. This amendment transitioned the financial records to categorize the earnings correctly, which is essential for the estate’s tax obligations.

The Current Dilemma

The amendment prompted the payroll service to generate a journal entry (JE), resulting in a negative liability in both the loan and withholding accounts. Normally, when such situations are handled promptly, the business can refund the amounts to the estate. However, due to the time taken from the employee’s passing to the filing of taxes, the estate had already transferred funds from the deceased’s 401(k). This transfer included deductions that complicate the matter further.

Seeking Solutions

To address the negative payroll liability, my first inclination is to determine if creating a journal entry to shift these amounts from payroll liabilities to payroll expenses would resolve the issue. However, I need to consider how this adjustment might impact our balance sheet.

By reclassifying these amounts, we would clear the negative liability, but it’s essential to understand the broader implications of such a move.

1. Effect on Payroll Liabilities: The immediate effect would be the elimination of discrepancies in the payroll liability accounts, providing a clearer financial picture.

2. Impact on Financial Statements: Shifting these amounts to payroll expenses would affect the overall expenses reported, which could influence financial ratios and performance evaluations