Deceased employee W2 amendment created negative payroll liability – Help?

Title: Navigating Payroll Challenges After the Passing of an Employee

Understanding Payroll Adjustments for Deceased Employees

The unexpected loss of an employee can create complex issues for businesses, particularly regarding payroll and tax obligations. A recent situation highlights these challenges, specifically how to manage payroll liabilities after an employee’s death. Here’s a breakdown of what happened and how it can be approached.

The Situation

At the end of December 2023, a valued member of the company sadly passed away. His paycheck for that final pay period was issued in 2024, which included deductions for a 401(k) loan and standard withholdings. Come January 2024, the payroll service generated a W-2 form for this individual, a move that, as it turns out, is not permissible for deceased employees.

Due to my absence at the company during this period, I was tasked with requesting an amendment of the deceased employee’s W-2 from our payroll service. The intent was to ensure accurate tax reporting, leading to the issuance of a 1099 form instead.

However, this amendment has since resulted in a journal entry from the payroll service, leaving behind a negative balance in both the loan and withholding liability accounts.

The Complication

Complicating matters further, it is my understanding that ideally, the company would process a refund of these withheld amounts back to the employee’s estate. However, significant time has elapsed since the employee’s passing, during which the estate transferred funds from his 401(k) accounts. Consequently, the deductions for the loan payment and regular withholding were also moved, complicating the refund process.

Seeking Solutions

To rectify this situation, the first question is about the best approach to address the negative liabilities that emerged from the W-2 amendment. One potential solution is to create a journal entry (JE) to shift these amounts from payroll liabilities to payroll expenses.

Impacts on the Balance Sheet

If this adjustment is made, the immediate effect will be the clearing of the negative liability from the balance sheet. However, it’s essential to consider the broader implications:

1. Cash Flow: Shifting to payroll expenses will affect the overall expenses of the business, which may impact profit margins.
2. Financial Reporting: Future financial statements will reflect an increase in expenses, potentially influencing stakeholders’ perception of the company’s financial health.
3. Tax Implications: Depending on the overall financial landscape, this could also