Navigating Payroll Challenges After an Employee’s Passing: A Case Study

The unexpected loss of an employee can create a complex web of financial and administrative challenges for a company. Recently, a situation arose involving the amendment of a deceased employee’s W2 that has left a negative payroll liability on the books. Here’s a breakdown of what happened and how to potentially resolve the issue.

Background Context

In late December 2023, one of the company’s owners sadly passed away. Although his employment officially ended upon his death, payday for that specific pay period didn’t occur until 2024. Unfortunately, this meant that he received a paycheck during this time, which included deductions for a 401(k) loan payment and other regular withholdings. Subsequently, a W2 form was generated for him at the end of January 2024. However, this practice is generally not permissible for deceased individuals.

The Confounding Payroll Amendment

As I was not part of the team during this period, I had to navigate the aftermath of the situation when the estate began preparing the deceased’s 2023 tax filings. To ensure compliance, I contacted our payroll service provider to amend the W2 and instead issue a 1099. This amendment led to a journal entry (JE) from the payroll service that created a negative liability in both the loan and withholding accounts.

Typically, it would be expected that these discrepancies would be rectified through a refund from the business to the estate. However, due to the elapsed time between the employee’s death and the tax filing, the estate had already redistributed the funds from the employee’s 401(k) accounts. Consequently, the loan payment and regular withholdings were also affected.

Seeking Solutions

Now, the pressing question is: how can we rectify the negative payroll liability? One potential fix is to make a journal entry that reallocates those amounts from the payroll liabilities to payroll expenses.

Considerations for Adjustment

While this strategy may seem straightforward, it’s important to understand its implications. Here are a few points to consider:

1. Impact on the Balance Sheet: Moving amounts from liability to expense will clear the negative liability from the balance sheet. However, this adjustment will also increase your expenses, which could affect net income.

2. Audit Trail and Documentation: Ensure that all changes are thoroughly documented. This will be crucial for any audits and will help maintain transparency in the financial records.

3. **Consultation with Financial Advisors