Navigating Payroll Challenges After an Employee’s Passing: A Guide to Amending W-2s and Managing Liabilities

The loss of an employee is a difficult time for any company, and navigating the associated financial processes can be particularly challenging. A recent situation highlighted an issue that can arise when handling payroll matters for a deceased employee, particularly when it comes to W-2 and tax reporting.

The Scenario

At the end of December 2023, a tragic event occurred: one of the company owners passed away. A paycheck was processed during that pay period, which fell in January 2024. This paycheck included deductions from the employee’s pay for a 401(k) loan payment and standard withholdings. However, a W-2 was issued for the deceased employee, which raised a question regarding compliance with tax regulations, as it is generally not permissible to issue W-2 forms posthumously.

As the new employee responsible for payroll matters, you were faced with addressing this situation when the deceased’s taxes were being filed by the estate. The payroll service was instructed to amend the W-2, transitioning the reporting responsibility to a 1099 format, which applicable in such unfortunate circumstances.

The Complications

However, this amendment triggered a journal entry from the payroll service, resulting in a negative liability in both the loan and withholding accounts. Typically, under timely conditions, the company would reimburse the estate for these amounts. Unfortunately, due to the delay between the owner’s passing and the tax filing, the estate had already relocated the funds from the employee’s 401(k) account to another account, along with the associated loan payments and withholdings.

Seeking Resolution

The pressing question is how to rectify this discrepancy. One possible solution involves making a journal entry to transfer the amounts from the payroll liabilities account to the payroll expenses account. But what implications does this have for the balance sheet, aside from eliminating the negative liability?

Understanding the Impact on Your Balance Sheet

When you adjust the payroll liabilities to clear the negative amounts, the corresponding entry to payroll expenses will effectively reflect that these liabilities are no longer outstanding. While this action will resolve the immediate issue of negative balances, it’s crucial to consider that this may also affect your financial reports, showcasing an increase in expenses.

To ensure a comprehensive understanding and proper handling of such situations, consult with a financial advisor or accountant. They can provide tailored guidance on the correct Accounting practices to apply, ensuring compliance while accurately reflecting the company’s