Addressing Payroll Challenges After a Deceased Employee’s W-2 Amendment

The unfortunate passing of an employee can lead to unexpected complications in payroll and tax management. Recently, a situation arose involving a company whose owner passed away at the end of December 2023. This case raised critical questions regarding payroll practices and necessary amendments during tax season — and the subsequent effects on the business’s financial records.

Understanding the Situation

As the timeline unfolded, payday for the final pay period of the deceased employee occurred in January 2024, resulting in the issuance of a paycheck. Standard deductions, including a 401(k) loan repayment, were withheld. However, a late W-2 was generated in January 2024, which is typically discouraged following the death of an employee.

Unaware of this situation at the time, the new payroll administrator had to navigate the complexities of amending the W-2 for the deceased employee when the estate’s taxes were prepared. The payroll service was instructed to amend the W-2 and issue a 1099 instead. Unfortunately, this amendment triggered a journal entry (JE) from the payroll service, resulting in negative liabilities appearing in both the loan and withholding accounts.

The Compounding Issue

In an ideal scenario, any overpaid amounts would be reimbursed to the estate promptly. However, due to the lengthy delay between the employee’s passing and tax filing, the estate had already redistributed funds from the deceased’s 401(k) account. Consequently, the corresponding deductions for the loan payments and regular tax withholdings were also reallocated.

This situation leaves the payroll administrator with a crucial question: How can the financial records be corrected?

Potential Solutions

One option to rectify this issue may involve creating a journal entry to transfer the amounts from payroll liabilities to payroll expenses. This approach could effectively eliminate the negative balances in the liability accounts. However, it’s important to understand the broader implications of this action on the company’s financial statements.

Impact on Financial Records

Making this adjustment could clear up the negative liabilities, positively presenting the balance sheet. However, it will shift the financial burden from liabilities to expenses, effectively reflecting a reduction in net income for that Accounting period. This change may affect cash flow projections and financial ratios moving forward, which are vital for strategic planning.

Conclusion

Navigating payroll discrepancies following an employee’s death can be particularly challenging. It’s vital to act swiftly and consult with financial professionals to explore the best course of action for