Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Challenges Following the Death of an Employee: A Call for Guidance

The unexpected passing of an employee can create complex payroll scenarios for any business. Recently, a situation arose within a company where a long-time owner passed away at the end of December 2023, leading to complications surrounding payroll and tax filings.

In this particular case, the owner received their final paycheck in 2024, which understandably included both a 401(k) loan payment and standard deductions. At the end of January 2024, a W-2 form was generated for the deceased employee. However, this practice is typically disallowed for individuals who are no longer living, prompting a need for review and correction.

As I was not part of the team when these events transpired, I quickly learned that, to address the deceased’s 2023 tax obligations, a request was made to the payroll service provider to amend the original W-2 and issue a 1099 instead. This led to a necessary journal entry (JE) from the payroll services, which inadvertently resulted in a negative liability appearing in both the loan and withholding accounts.

Complicating matters further is the time elapsed between the owner’s passing and the tax filing process. By the time the estate was prepared to settle the tax matters, the funds from the deceased’s 401(k) account had already been transferred to another account. Consequently, the associated loan payments and regular deductions had been shifted as well, adding another layer of confusion regarding the proper steps to rectify the payroll records.

To address this issue, I am seeking advice on the appropriate method to rectify this situation. Is the solution as straightforward as creating a journal entry to reallocate these amounts from payroll liabilities to payroll expenses? If so, what impact would this adjustment have on the overall balance sheet, aside from eliminating the negative liability?

Your insights and suggestions would be greatly appreciated as we seek to resolve this payroll dilemma effectively and ensure accurate Accounting practices are upheld during this challenging time.