Navigating Payroll Complications Following the Passing of an Employee

The unexpected loss of an employee can create significant challenges, particularly in the realm of payroll and tax reporting. This blog explores a real-world scenario involving a deceased employee’s W-2 amendment that ultimately resulted in negative payroll liabilities. If you find yourself in a similar situation, understanding the processes involved can help you navigate these turbulent waters.

The Background

In late December 2023, a key member of a company passed away. As unfortunate as this event was, it led to complications regarding payroll for the final pay period and subsequent W-2 reporting. Notably, the final paycheck, processed in early 2024, included deductions for a 401(k) loan repayment and standard withholdings. To complicate matters further, a W-2 was issued at the end of January 2024, which is generally prohibited for deceased individuals.

The Dilemma

With the business’s estate in mind, the task of filing the deceased employee’s taxes fell on the shoulders of the payroll administrator, who was still getting acquainted with the company’s procedures. This led to a crucial request for the payroll service provider to amend the W-2 and instead issue a 1099 form for tax reporting.

However, this amendment created unintended consequences: a journal entry (JE) from the payroll service resulted in a negative liability within the accounts for loan payments and withholdings. In ordinary circumstances, it would be expected that these amounts would be refunded to the deceased’s estate. Unfortunately, due to the protracted period between death and tax filing, the estate had already relocated the funds from the employee’s 401(k) to another account, thereby complicating the issue further as the pertinent payments also shifted.

Seeking a Solution

The dilemma now lies in rectifying these negative liabilities on the balance sheet. A common approach to resolving this situation would be to create a journal entry that transfers the amounts from payroll liabilities to payroll expenses. This transfer would clear the negative liability, but one may wonder about the broader implications for the balance sheet.

Implications of the Adjustment

Adjusting these entries would effectively neutralize the negative liability, allowing for a more accurate financial representation. However, it’s critical to consider that moving amounts from payroll liabilities to payroll expenses impacts net income, which in turn can affect the overall financial position of the business. As payroll expenses increase, this can have an influence on profit calculations for the period in question.