Addressing Payroll Liabilities for a Deceased Employee: A Guide for Business Owners

The passing of an employee can introduce complex challenges for a business, especially when it comes to payroll management and tax reporting. In one recent case, a company faced issues after a beloved owner passed away at the end of December 2023. Complicating matters, a paycheck was issued during the subsequent pay period in 2024, which included withholdings for a 401(k) loan and standard deductions. Furthermore, a W-2 was generated at the close of January 2024, which has since been identified as problematic, as federal guidelines prohibit such actions for deceased individuals.

With the employee’s tax return being prepared by their estate, it became necessary to amend the original W-2 and instead issue a 1099. Unfortunately, this amendment has resulted in an Accounting entry from the payroll service provider that led to a negative liability balance across the loan and withholding accounts.

Given that the time frame between the owner’s death and the tax filing was significant, the estate had already transferred funds from the deceased’s 401(k) into another account, complicating the ability to refund these amounts directly to the estate, as one might typically do in a more timely scenario.

Finding a Solution

So, how can a business navigate these murky waters? One potential resolution could involve creating a journal entry (JE) that reclassifies the amounts from payroll liabilities to payroll expenses. This action would address the negative liability and help clarify your financial statements.

But what does this adjustment truly mean for your balance sheet?

1. Clearing Negative Liabilities: Reclassifying these amounts will eliminate the negative figures from your liability accounts, providing a more accurate portrayal of your payroll obligations.

2. Impact on Expenses: Shifting these costs to payroll expenses will increase your overall business expenses in the short term, which could influence your bottom line during that reporting period.

3. Long-term Considerations: While this adjustment resolves immediate discrepancies, it’s crucial to document the entire process thoroughly. Future auditors or financial reviews may inquire about the nature of these transactions, especially given the unique circumstances.

Next Steps for Your Business

If your business finds itself in a similar predicament, it’s essential to consult with a tax professional or accountant who can provide tailored advice based on the specificities of your situation. Keeping accurate records and ensuring compliance with federal and state regulations will help safeguard your