Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Challenges After Employee Passing: A Case Study

In the intricate world of payroll management, unforeseen challenges can arise, especially in sensitive situations such as the passing of an employee. A recent case highlights a critical issue related to W-2 amendments and payroll liabilities that warrants discussion.

The Situation

In late December 2023, the unfortunate passing of one of the company’s owners led to a series of payroll complications. During the first payday of 2024, a paycheck was issued, which included standard deductions such as a 401(k) loan repayment. Subsequently, in January 2024, a W-2 form was generated for the deceased employee—an action typically prohibited posthumously.

Due to the author’s lack of involvement at the time these events unfolded, they were faced with the task of rectifying the situation when tax filings were initiated by the deceased’s estate. This process required the payroll service to amend the W-2 and issue a 1099 instead.

The Complication

However, this amendment created a journal entry from the payroll service, resulting in a negative liability in both the loan and withholding liability accounts. Ideally, a prompt refund to the estate would have been arranged to resolve these discrepancies. Unfortunately, due to the elapsed time between the passing and the tax filing, the estate had already transferred funds from the employee’s 401(k) accounts, complicating the refund process.

Seeking Solutions

Now confronted with this complex scenario, the author is grappling with the best course of action. The question remains: How can one effectively address the negative liability created by the W-2 amendment?

One potential solution involves making a journal entry (JE) to transition the amounts from payroll liabilities to payroll expenses. But what implications would this adjustment have on the company’s balance sheet, apart from relieving the negative liability?

Possible Outcomes

1. Clearing Negative Liabilities: By moving the amounts associated with the misclassified payroll liabilities, you can effectively eliminate the negative figures, bringing financial clarity back to the accounts.

2. Impact on Financial Statements: Transitioning these amounts to payroll expenses would reduce total liabilities and effectively increase overall expenses for the period. This could impact net income, highlighting the need for careful consideration during financial reporting.

3. Documentation and Audit Trail: It’s crucial to maintain thorough documentation of all adjustments made during this process. Ensuring that a clear Audit trail exists will safeguard against potential queries from tax