Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Liabilities After an Employee’s Passing: Guidance Needed

In December 2023, our company faced the unfortunate event of losing one of our valued employees. As we navigated the complexities of payroll related to this situation, several challenges arose that require our attention and expertise.

Firstly, it’s crucial to note that payday for the last pay period of the deceased employee fell in 2024. During this time, a paycheck was issued, which included standard deductions, such as a 401k loan repayment. Come January 2024, a W-2 was generated for this employee. However, I have since learned that issuing a W-2 for a deceased individual is not compliant with tax regulations.

As someone who was not part of the team when this payroll activity occurred, I found myself having to request an amendment to the employee’s W-2 from our payroll service provider when the estate was preparing the 2023 tax filings. The aim was to correct this oversight by issuing a 1099 instead.

Unfortunately, the amended W-2 resulted in a journal entry (JE) from the payroll service, which has created a negative liability in both the loan and withholding accounts. Typically, in a more streamlined process, the business would refund these amounts to the estate. However, due to the significant time gap between the employee’s passing and the tax filings, the funds from the decedent’s 401k accounts have already been relocated, preventing a traditional refund approach.

Now, we are faced with the pressing question: how can we rectify this situation? Is it simply a matter of making a journal entry to transfer the amounts from payroll liabilities to payroll expenses? Additionally, I’m curious about how this adjustment would impact our balance sheet, beyond merely alleviating the negative liability.

The complexity of payroll, especially in sensitive cases like this one, can be daunting. If you have encountered a similar situation or possess knowledge in this area, your insights would be invaluable. Thank you for your guidance as we seek to resolve these payroll discrepancies.