Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Challenges After the Loss of an Employee: A Case Study

The passing of an employee is never an easy situation for a business, not only emotionally but also administratively. Recently, a scenario unfolded that highlights the complexities involved with payroll practices following an employee’s death, raising questions that many business owners may find relevant.

The Situation

In late December 2023, one of the company’s owners passed away. Unfortunately, the regular payroll cycle meant that a paycheck was issued in 2024 for work performed earlier, which included automatic deductions for a 401(k) loan payment. As the calendar changed to January, a W-2 was generated for the deceased, which led to complications, as it is against IRS regulations to issue tax forms for a deceased individual.

At the time of this incident, I was new to the company. However, I found myself responsible for ensuring that the estate’s taxes were accurately filed. To comply with IRS guidelines, I contacted our payroll service provider and requested an amendment to the W-2, ultimately leading to the issuance of a 1099 form instead.

The Complications

This W-2 amendment triggered a journal entry from our payroll service that created a negative balance in the loan and withholding liability accounts. Under typical conditions, businesses would process refunds to the estate covering these liabilities. However, due to the lengthy delay between the employee’s passing and the tax filing, the estate had already transferred the 401(k) funds to another account, meaning the corresponding loan payments and deductions were also affected.

Finding a Solution

This situation begs the question: how can we rectify the negative liability status created in our accounts? While I’m exploring potential solutions, I am considering whether a simple journal entry (JE) could resolve the issue by moving amounts from payroll liabilities to payroll expenses.

Implications of the Proposed Solution

If this approach is valid, it would eliminate the negative liability on the balance sheet, but it also raises concerns about the broader impact on financial statements. What does this mean for our overall financial picture? Decreasing liabilities while increasing expenses could affect net income, which may, in turn, influence stakeholders’ perceptions.

Conclusion

Addressing payroll discrepancies resulting from the passing of an employee can be intricate, particularly when delays complicate the situation. It is crucial to adopt a methodical approach to ensure compliance with Accounting standards and IRS regulations. Seeking guidance from Accounting professionals can provide clarity and ensure appropriate steps are taken to restore