Navigating Payroll Challenges: Handling W2 Amendments for Deceased Employees

The loss of an employee is never easy, particularly for a business owner. Unfortunately, navigating the financial and administrative responsibilities that accompany such a situation can pose significant challenges. One of the issues faced with deceased employees is correctly managing payroll liabilities, especially concerning W2 forms and 401k contributions.

The Scenario

Recently, a company owner passed away at the end of December 2023. As the payroll cycle continued into the new year, a paycheck was issued in early January 2024 that included deductions for 401k loan payments and other standard withholdings. At the close of that month, a W2 was generated for the deceased, which, unfortunately, is typically not permissible for someone who has passed away.

Since I was not with the company at the time of this transaction, I had to reach out to our payroll service provider to amend the W2 and issue a 1099 for the deceased employee, especially since the estate was in the process of filing taxes.

However, this amendment generated a journal entry (JE) from the payroll service that created a negative balance in both the loan and withholding liability accounts.

The Complications

As per standard procedure, if the situation were addressed in a timely manner, the company would have refunded any incorrect amounts directly to the estate. However, by the time we initiated the W2 amendment, the estate had already moved the funds from the employee’s 401k accounts. This included the loan payment and regular withholding, complicating our financial records further.

Seeking Solutions

The pressing question is how to rectify this negative liability situation. One potential solution I’m considering is to create a journal entry to transfer those amounts from the payroll liabilities to payroll expenses. However, it’s crucial to understand the ramifications of this action on our financial statements.

Key Considerations:

1. Impact on the Balance Sheet: By shifting the liabilities to expenses, the negative balance would be cleared, but it’s essential to analyze how this maneuver will affect the overall financial health of the business. Will this adjustment disrupt our financial ratios or impact our tax obligations?

2. Documentation and Compliance: Ensuring that all entries are well-documented will be vital for compliance and for future audits. The adjustments need to be transparent and justified to avoid potential complications down the line.

3. Consulting Financial Professionals: Given the complexity of tax laws and payroll