Deceased employee W2 amendment created negative payroll liability – Help?

Understanding Payroll Liabilities After an Employee’s Passing: A Case Study

Navigating the complexities of payroll and tax liabilities can be particularly challenging in the unfortunate event of an employee’s death. A recent situation involving a deceased employee, who passed away at the end of December 2023, highlights some common pitfalls and necessary actions that need to be taken.

The Scenario

In this case, the employee was issued a paycheck for a pay period that occurred after his death in 2024. Despite his passing, a 401(k) loan repayment and other regular deductions were processed, resulting in the issuance of a W-2 form at the end of January 2024—an action that is generally not permissible for deceased individuals. As this event unfolded while I was not part of the company, I was tasked with rectifying the situation after the estate’s tax filings began.

Upon my inquiry, the payroll services provider was called upon to amend the W-2 and instead issue a 1099 form for the deceased employee. However, this amendment resulted in a journal entry (JE) that introduced a negative liability within our loan and withholding accounts.

The Complication

Typically, in more timely scenarios, the business would reimburse the estate for the deductions taken from the deceased’s paycheck. Unfortunately, due to the delay between the employee’s death and the tax filing, the funds from the employee’s 401(k) accounts had already been moved to another account. This situation complicated any potential reimbursements, as the loan payments and regular tax withholdings had also been transferred.

Seeking Solutions

In facing these challenges, the critical question arises: how can the company effectively address the negative liabilities left in its accounts? One potential solution is to make a journal entry to reclassify those amounts from payroll liabilities to payroll expenses.

Impact on Financial Statements

Adjusting the entries can eliminate the negative liability from the balance sheet; however, it is essential to understand its implications. Reclassifying these amounts will not only rectify the financial record but may also alter other aspects of your balance sheet. Specifically, the conversion from liability to expense could impact profit margins, given that those funds would now be treated as an expense rather than a liability owed to the employee or estate.

Conclusion

Handling payroll discrepancies after an employee’s death can be intricate and requires prompt attention to avoid complications down the line. Amending payroll records to reflect accurate liability and expense positions is necessary for maintaining the integrity of your financial