Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Challenges Following the Loss of an Employee

The passing of an employee, especially an owner, can be an incredibly challenging event for any organization. Beyond the emotional impact, there can be significant logistical and financial implications to address, particularly concerning payroll and tax reporting. A recent scenario has highlighted some complexities that can arise in this situation.

In late December 2023, a company owner sadly passed away. Due to timing, the final paycheck was processed in 2024, which included deductions for a 401(k) loan and other regular withholdings. Consequently, a W-2 form was generated at the end of January 2024, a practice that raises questions, as typically, retaining an active payroll record for a deceased individual is not permissible.

For those who were not part of the company during this period, the aftermath can be tricky to navigate. As the estate of the deceased was preparing to file taxes for 2023, it became necessary to request that the payroll service amend the W-2 and subsequently issue a 1099 form instead.

However, this amendment led to an unexpected complication, resulting in a journal entry from the payroll service that introduced a negative balance to both the loan and withholding liability accounts. Understanding that under normal circumstances the organization would refund any erroneous amounts to the estate, the time gap between the employee’s passing and tax filing complicated matters. Specifically, funds had already been transferred out of the deceased’s 401(k) accounts, along with associated loan payments and withholdings.

So, how does one rectify such a scenario?

Steps to Resolve Payroll Liabilities

1. Review Payroll Entries: First, it’s crucial to conduct a thorough review of the payroll entries related to this situation. Check for inaccuracies post-amendment and confirm how the entries were adjusted.

2. Make Journal Entries Appropriately: If the payroll liabilities appear incorrect, creating a journal entry (JE) to transfer the amounts from the payroll liabilities to payroll expenses may be an appropriate solution.

3. Consider the Impact on Financial Statements: It’s important to assess how this adjustment impacts your balance sheet. Moving amounts from liabilities to expenses will indeed clear the negative balance but can also affect profitability metrics. This change translates to a reduced liability position without altering the overall cash flow; however, it could have implications for financial reporting.

4. Consult with a Professional: Given the complexity of the situation, it may be beneficial to consult with an accounting