Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Challenges After the Loss of an Employee: A Guide for Business Owners

The loss of an employee is never easy, both emotionally and logistically, especially when it comes to handling payroll matters. Recently, I encountered a particularly complex situation involving a recently deceased employee, and I believe sharing this experience can help others navigate similar challenges.

In late December 2023, one of the company owners passed away. Unfortunately, the timing of payroll added complications, as payday for that pay period fell into January 2024. As a result, the late owner received a paycheck, which included deductions for a 401(k) loan and standard payroll withholdings. Compounding this issue, a W-2 was issued at the end of January 2024, a process generally considered inappropriate for someone who has passed.

Since I was not part of the team when this occurred, I had to step in when it came time to file taxes for 2023 on behalf of the deceased’s estate. This required requesting an amendment to the W-2 from our payroll service, ultimately resulting in a 1099 form being issued instead.

However, amending the W-2 gave rise to a journal entry from our payroll service provider that resulted in negative balances in both the loan and withholding liability accounts. Typically, once a situation like this is rectified in a timely manner, businesses would refund any outstanding amounts to the estate. Unfortunately, due to the passage of time between the employee’s death and the tax filing, the estate had already transferred funds from the deceased’s 401(k) accounts to another entity, which included the corresponding loan payments and withholdings.

Now, I’m looking for guidance on how to resolve this negative liability issue. Is it sufficient to create a journal entry to relocate those amounts from payroll liabilities to payroll expenses? If that’s the case, how will this adjustment impact my balance sheet, aside from eliminating the negative liability?

If you’ve experienced something similar or have expertise in payroll management following the unfortunate loss of an employee, your insights would be greatly appreciated. Your recommendations could not only help clarify this situation but also provide valuable guidance for others who might find themselves in a comparable predicament. Thank you in advance for your support!