Navigating Payroll Complications After the Loss of an Employee: A Case Study

The passing of an employee can introduce unexpected complexities to a business’s payroll process, especially when it comes to tax implications and Accounting adjustments. Recently, a situation unfolded following the unfortunate death of a company owner at the end of December 2023. This scenario highlights the potential challenges in handling payroll and tax documents for deceased employees and offers insights into remedies for resolving negative payroll liabilities.

The Background

In the wake of the owner’s death, a paycheck was issued during the subsequent pay period in 2024, which included deductions for a 401(k) loan repayment and standard withholdings. At the beginning of February, a W-2 form was generated for the deceased, a move that many financial experts deem inappropriate for a deceased individual.

Notably, the circumstances leading to this situation presented challenges since the current payroll administrator was not involved when these transactions occurred. When it came time to file taxes for the deceased’s estate, a request was made to the payroll service provider to amend the W-2 and issue a 1099 form instead. This correction, however, triggered a journal entry (JE) from the payroll service, resulting in negative balances in both the loan and withholding liability accounts.

The Complications

Under typical conditions, businesses can refund amounts to the estate when erroneous payroll deductions occur. Yet, due to the timeline of events—the considerable delay between the owner’s death and tax filing—the estate had already transferred funds from the employee’s 401(k) accounts to another account. Consequently, this transfer affected the original loan and withholding deductions.

Seeking Solutions

The primary question arises: How can these discrepancies be resolved? A potential corrective action is to execute a journal entry that reallocates these funds from payroll liabilities to payroll expenses.

Implications of the Adjustment

Before proceeding, it is crucial to consider the impact on the balance sheet. Addressing the negative liabilities in this manner can clear up discrepancies, but it is essential to understand the broader financial implications. Adjusting the entries will:

1. Eliminate Negative Liabilities: This action will address and resolve the persistent negative balances in the liability accounts.

2. Affect Profit and Loss: Moving amounts to payroll expenses will increase expenses on the profit and loss statement, which could influence net income for the period.

3. Maintain Compliance: Ensuring that the payroll records align with legal requirements following the unfortunate passing of