Resolving Payroll Complications Following the Passing of an Employee

The unfortunate passing of an employee can lead to complex payroll issues, especially when it comes to tax reporting and Accounting. A recent situation faced by a company highlights the intricacies involved when an employee dies, particularly concerning the issuance of W-2 forms and the management of payroll liabilities.

A Challenging Situation

The scenario began with the passing of one of the company owners at the end of December 2023. Unfortunately, payday for that pay period fell in early 2024, leading to the issuance of a paycheck that included deductions for a 401(k) loan repayment and other standard withholdings. To complicate matters further, a W-2 was generated at the end of January 2024 for this deceased employee, which some tax professionals argue should not have been issued.

Since the individual responsible for payroll operations was not present during this time, the necessary tax documents were not appropriately managed at first. When the deceased’s estate began to file taxes, an amendment was made to the W-2 issued by the payroll service provider, which required the issuing of a 1099 instead.

This W-2 amendment, however, resulted in a journal entry (JE) from the payroll service that created a negative liability in both the loan and withholding accounts. The crux of the issue lies in the fact that much time had passed since the employee’s death, resulting in the estate moving funds from the deceased’s 401(k) accounts to different accounts. Consequently, the remaining loan and withholding amounts became problematic.

Finding a Solution

The primary question arising from this situation is: How can these negative liabilities be reconciled?

In addressing this issue, one possible approach involves creating a journal entry to transfer the amounts from payroll liabilities to payroll expenses. This would effectively clear the negative liability on the balance sheet. However, it’s crucial to understand the broader implications of this adjustment:

1. Impact on Financial Statements: Transferring these amounts may improve the appearance of the balance sheet by eliminating the negative liabilities. However, it’s important to recognize that it will also affect the profit and loss statement since it would increase payroll expenses.

2. Compliance Considerations: Before making any Accounting adjustments, it’s imperative to ensure compliance with tax regulations and payroll service agreements. Consultation with a tax professional or Accounting expert can provide clarity on the best course of action.

3. Communication with the Estate: It’s advisable to