Deceased employee W2 amendment created negative payroll liability – Help?

Addressing Payroll Liabilities Following the Passing of an Employee: A Guide

Navigating payroll and tax responsibilities can become particularly complex in the unfortunate event of an employee’s passing. This was recently illustrated in a scenario involving a deceased employee whose payroll records required amending, resulting in unexpected negative liabilities on the company’s books.

The Situation

In late December 2023, a key figure and owner of a company passed away. As is common, the payroll period that included the time of their passing extended into January 2024, resulting in a paycheck being issued posthumously. From this paycheck, deductions for a 401k loan payment and other regular contributions were withheld. To complicate matters, a W-2 form was generated at the end of January 2024, a practice that is generally prohibited for deceased individuals.

The Consequences

Due to my absence during these events, when the estate began filing taxes for 2023, I was required to liaise with our payroll service provider to amend the W-2 and issue a 1099 form instead. Unfortunately, this amendment triggered a journal entry (JE) from our payroll service, leading to a negative liability recorded in our loan and withholding accounts.

Compounding this issue is the time that has elapsed since the employee’s death. By the time of filing, the estate had already reallocated funds from the deceased’s 401k account, including the deducted loan payments and withholdings, making it impossible to refund those amounts to the estate per standard protocol.

Seeking a Solution

The question now is how to rectify the negative liabilities left in our accounts. Is it feasible to simply create a journal entry transferring these amounts from payroll liabilities to payroll expenses? If this adjustment is made, what implications will it have on our balance sheet, aside from eliminating the negative liability?

Recommendations

1. Consult a Tax Professional or CPA: Given the complexities surrounding tax regulations for deceased employees, it may be prudent to consult with a tax professional for tailored guidance.

2. Journal Entry Adjustment: If opting to make the necessary journal entry, it’s important to ensure that all amounts are accurately documented. This adjustment will clear the negative liability but may also impact your payroll expenses, thereby affecting your overall financial reporting.

3. Document Everything: Maintain thorough records of all communications and transactions related to this issue. Documentation will be vital for audits and future reference.

4. Review Policies: Finally, consider reviewing