Deceased employee W2 amendment created negative payroll liability – Help?

Handling Payroll Liabilities After a Deceased Employee: Navigating W-2 Amendments

Managing payroll can be complicated, particularly when faced with unexpected situations, such as the passing of an employee. Recently, a dilemma arose within a company regarding the payroll implications tied to a deceased employee, prompting questions about how to rectify resulting liabilities.

The Situation at Hand

In December 2023, one of the company’s owners passed away. Unfortunately, due to the timing of payroll schedules, this individual was issued a paycheck in January 2024, which included deductions for a 401(k) loan and other withholdings. By the end of January, a W-2 was generated for the deceased employee—a practice that, as many are informed, is generally prohibited for someone who has passed away.

Due to the lack of familiarity with this situation—having not been involved at the time—the responsibility fell upon the current team to amend the W-2 through the payroll service company. In a bid to correct the error, the company requested that the payroll service generate a 1099 instead. However, this amendment resulted in a journal entry from the payroll provider that left negative liabilities in the accounts related to loan and withholding.

Understanding the Consequences

From what can be understood, in more straightforward circumstances, the business would simply refund the amounts back to the estate of the deceased. But in this case, considerable time elapsed after the employee’s passing, leading to the funds in the 401(k) accounts being transferred elsewhere. Consequently, the loan payments and withholding amounts were also moved, complicating the situation further.

Seeking a Solution

The question that arises is: How can this be rectified? One possible solution could involve creating a journal entry to transfer the liabilities from the payroll accounts to payroll expenses. However, it’s critical to consider the impact of such an action.

Impact on Financial Statements:

1. Balance Sheet Adjustments: Clearing the negative liability will make your balance sheet appear more accurate, reflecting the true financial situation without the burden of erroneous negative figures.

2. Expense Recognition: Moving these amounts into payroll expenses means acknowledging that these funds are no longer liabilities but expenses incurred by the business. This transition will alter your income statement as well.

3. Compliance and Documentation: Maintaining a clear paper trail and ensuring compliance with tax regulations will be essential throughout this process to avoid complications in future audits.

In summary, addressing the payroll liabilities stemming