Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Challenges Following the Passing of an Employee

The unexpected passing of an employee can create a host of challenges for any company, particularly when it comes to payroll processing and tax reporting. A recent case illustrates these complexities, especially concerning the handling of a deceased employee’s W-2 and associated liabilities.

In December 2023, one of the company’s co-owners sadly passed away. As timing would have it, the payday for that payroll cycle occurred in January 2024. Unbeknownst to the new payroll administrator, the deceased employee was issued a paycheck during this period which included deductions for a 401(k) loan and regular withholdings. Consequently, a W-2 form was generated at the end of January 2024, a common oversight since issuing a W-2 for a deceased individual is not permissible.

The current payroll administrator, who was not with the company during the time of the incident, faced the task of rectifying the situation when it came time for the estate to file the individual’s 2023 taxes. To address this, the payroll service provider was requested to amend the original W-2 and instead issue a 1099 to reflect the accurate tax status.

However, this amendment led to the creation of a journal entry from the payroll service that left a negative liability in both the loan and withholding accounts. Typically, it is standard practice for a business to refund these amounts to the estate in a more timely manner. Unfortunately, due to the significant time lapse between the employee’s demise and the tax filings, the estate had already transferred funds from the employee’s 401(k) accounts to another account. This transfer also affected the related loan payments and withholdings.

Now, the pressing question arises: how can this situation be resolved?

A potential remedy could involve creating a journal entry to reclassify the amounts from payroll liabilities to payroll expenses. This could effectively clear the negative balances on the liability accounts. However, it is crucial to understand the broader implications of such an action. Reclassifying these amounts may impact the balance sheet beyond simply eliminating the negative liability.

In conclusion, it is essential to approach this situation with caution and perhaps seek advice from a financial professional. Addressing payroll discrepancies related to a deceased employee requires not just immediate corrective actions, but also a thorough understanding of how these changes might ripple through your company’s financial reporting.