Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Challenges After an Employee’s Passing: How to Address a W2 Amendment and Liability Issues

The unexpected loss of a key team member can create a series of complex challenges for any business. One such issue arose recently when a company faced an unusual payroll liability situation following the unfortunate passing of one of its owners at the close of December 2023. The owner was issued a paycheck during the pay period spanning into January 2024, which included deductions for a 401k loan and standard withholdings. However, complications emerged when the appropriate tax documentation was addressed.

Upon preparing the estate’s taxes for the deceased owner, it became evident that a W2 was erroneously issued, which raised red flags regarding compliance. Typically, issuing a W2 post-mortem is not permissible, prompting the need for action with the payroll service provider to amend the W2 and generate a 1099 instead.

After the amendment was processed, an unexpected journal entry (JE) from the payroll service created a negative liability within both the loan and withholding accounts. This scenario posed a challenge, particularly given that the estate had already transferred funds from the deceased employee’s 401k to another account. This transfer included payments related to the loan and standard deductions, complicating the ability to refund these amounts to the estate.

Steps to Resolve Payroll Liabilities

As a professional tasked with addressing this situation, the primary question arises: how to rectify the negative payroll liability created by the W2 amendment?

A potential solution may involve creating a journal entry to reallocate these amounts from the payroll liabilities back into payroll expenses. However, it is crucial to consider the broader implications of this adjustment on your financial statements.

What to Consider When Adjusting Payroll Liabilities

1. Impact on Financial Statements: Moving amounts from liability to expense accounts will clear the negative liability; however, this adjustment may also affect your cash flow and overall profitability. It’s important to maintain a balance between correcting the liability and accurately representing your fiscal position.

2. Documentation and Audit Trail: Ensure all adjustments are well-documented. Annotations regarding why these changes were made will be beneficial for future audits or inquiries.

3. Consult with Tax Professionals: Given the complexity of tax implications in cases involving deceased employees, consulting with a tax advisor or accountant familiar with estate and payroll tax laws will provide clarity and ensure compliance.

4. Review Company Policies: Lastly, this experience could serve as a