Addressing Payroll Complications Following an Employee’s Passing: A Guide for Employers

Navigating payroll issues in the wake of a deceased employee can be challenging, especially when it involves tax implications and liability adjustments. This post discusses the complexities that can arise and outlines potential solutions for employers in similar situations.

The Challenge

Recently, a business faced a unique payroll dilemma following the passing of one of its owners at the end of December 2023. Despite the employee’s death, a paycheck was issued for the final pay period in 2024. This paycheck included deductions for a 401(k) loan repayment and regular contributions. To complicate matters further, a W-2 was issued at the end of January 2024 for a deceased individual, a practice typically frowned upon.

Due to timing, the company found itself in a position where it had to amend the deceased’s W-2 for tax filings by the estate and issue a 1099 instead. This amendment resulted in a journal entry from the payroll service provider, which inadvertently created a negative balance in the loan and withholding liability accounts.

Understanding the Implications

In an ideal scenario, a business would timely refund the amounts associated with the employee’s improperly processed payments back to the estate. However, due to the time elapsed between the owner’s passing and the tax filings, the estate had already shifted the funds from the employee’s 401(k) accounts. Consequently, both the loan payment and the regular deductions had been transferred as well.

Finding a Solution

To rectify this situation, business owners and payroll administrators may wonder about the best course of action. One suggested approach is to create a journal entry (JE) that transfers the negatively impacted amounts from the payroll liabilities to payroll expenses. Here are some key points to consider:

1. Journal Entry Impact: By moving these balances from payroll liabilities to payroll expenses, you would effectively clear the negative liability.

2. Balance Sheet Considerations: This transfer would also have implications for your company’s financial statements. While it eliminates the negative liability, it will increase payroll expenses on the income statement, which could affect your overall profitability for the period.

3. Consultation with a Professional: Given the complexities involved—especially those related to tax reporting and compliance—consulting with a tax professional or accountant is advisable. They can provide tailored guidance considering your specific circumstances.

Conclusion

Handling payroll for a deceased employee involves various nuances that can impact a company’s financial standing