Navigating Payroll Challenges After an Employee’s Passing: A Guide for Employers

The unfortunate passing of an employee can lead to complex payroll situations that require careful handling. Recently, we encountered a scenario that highlights some critical considerations when addressing payroll liabilities for deceased employees. This post outlines the key issues and potential solutions for businesses that find themselves in a similar predicament.

Understanding the Situation

In December 2023, one of our company owners passed away. Although this occurred before the year ended, the final paycheck for that pay period was issued in January 2024, resulting in deductions for a 401(k) loan payment and other regular withholdings. At the end of January, a W-2 was generated for the deceased, which raised an important compliance issue—issuing a W-2 for an employee who has passed away is generally not permissible.

Since I was not with the company at the time of these decisions, I had to step in when it was time to file taxes for the estate. As part of this process, I requested an amendment to the W-2 from our payroll service provider, which should have resulted in a corrected tax document, such as a 1099.

Complications Arise

However, the amended W-2 triggered a journal entry (JE) from the payroll company that inadvertently left a negative liability on our books concerning the loan and withholding accounts. Typically, under normal circumstances, the business would issue a refund to the estate for the erroneously withheld amounts. Unfortunately, due to the time elapsed since the employee’s death and the subsequent tax filing, the estate had already transferred funds from the employee’s 401(k) account, complicating the situation further.

Finding a Resolution

The question then arises: how should we address this Accounting issue? One potential approach might be to create a journal entry that transfers those amounts from the payroll liabilities to payroll expenses. This correction would clear the negative liability but it’s essential to understand its implications on your balance sheet.

Here’s what to consider:

1. Impact on Financial Statements: Moving amounts to payroll expenses instead of payroll liabilities would increase your expenses and decrease net income for that period. This reflects the actual cost borne by the company in terms of taxes and deductions.

2. Establishing a Clear Audit Trail: Ensure that all adjustments are well-documented. This includes a comprehensive explanation of the changes made and the rationale behind them to maintain transparency in your Accounting records.

3. **Consult