Addressing Payroll Issues Post-Employee Demise: A Case Study

Navigating the complexities of payroll and tax obligations can become even more challenging in the unfortunate event of an employee’s death. Recently, a business owner faced a scenario that highlighted some of these complications, and it serves as a valuable lesson for professionals managing payroll operations.

Understanding the Situation

At the end of December 2023, one of the company’s owners passed away. The regular payday for that pay period landed in 2024, during which a paycheck was issued. This paycheck included deductions for both a 401(k) loan payment and standard withholdings. Subsequently, a W-2 was generated at the end of January 2024 for the deceased employee, a practice generally considered unacceptable when it comes to deceased individuals.

Due to the current payroll administrator’s absence during this time, adjustments were required when the estate was preparing for 2023 tax filings. The new administrator took the necessary steps to request that the payroll service company amend the W-2 and issue a 1099 for the deceased employee.

However, the amendment resulted in a journal entry (JE) from the payroll service that unfortunately left a negative balance in the loan and withholding liability accounts. Typically, in more immediate situations, the business would issue refunds to the estate for those deductions; however, significant delays had occurred here, as the estate had already transferred funds from the employee’s 401(k) account, including those loan payments and withholdings.

Seeking Resolution

This conundrum raises an important question: How can one rectify this situation?

One potential solution involves making a journal entry to reallocate those amounts from payroll liabilities to payroll expenses. However, it is crucial to understand the ramifications of such adjustments on your balance sheet.

1. Clearing Negative Liabilities: This adjustment would effectively eliminate the negative figures currently recorded in the liability accounts, providing a clearer financial picture.

2. Impact on Financial Statements: Shifting amounts to payroll expenses will increase your overall expenses for the period, which could potentially affect profitability metrics and financial reporting. It’s vital to ensure that this adjustment is documented properly to maintain transparency and accuracy in your financial records.

3. Consulting a Professional: Given the nuances of Accounting and compliance, it may be wise to consult with a financial advisor or accountant specializing in payroll issues. They can provide guidance tailored to your specific situation and ensure that all actions taken are compliant with