Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Challenges After the Passing of an Employee: A Guide for Businesses

The loss of a team member can be a challenging time for any organization, both emotionally and operationally. An unforeseen complication arises when a deceased employee’s payroll and tax documentation needs reevaluation. Recently, I encountered such a situation, and I’m sharing the details in hopes of guiding others who may find themselves in a similar predicament.

The Scenario

In December 2023, one of our company owners passed away. Unfortunately, the payday for the corresponding pay period fell in 2024, leading to the issuance of a paycheck that included withholdings for a 401(k) loan payment and other regular deductions. To complicate matters, by the end of January 2024, a W-2 had been issued for the deceased employee—a practice that generally should not occur.

As I was unfamiliar with the events leading up to this situation due to my joining the company subsequently, I took steps to rectify the matter. In support of the estate’s tax filing for 2023, I contacted our payroll service provider to amend the original W-2 and issue a 1099 instead.

Unintended Consequences

However, the amendment process created a journal entry (JE) from the payroll service that resulted in a negative liability in our loan and withholding accounts. Historically, under more timely circumstances, a business would refund these amounts to the estate. However, due to the elapsed time since the employee’s passing, the estate had already transferred the funds from the deceased’s 401(k) accounts, impacting the associated loan payment and withholdings.

Finding a Solution

Now, the question arises: how do I resolve this negative liability issue? Is it sufficient to create a journal entry to reclassify these amounts from payroll liabilities to payroll expenses? If this is the case, what implications will this adjustment have on the balance sheet beyond clearing the negative liability?

Next Steps

To address this challenge effectively, you may consider the following steps:

1. Consult with a Tax Advisor or Accountant: Before making any journal entries, it’s wise to seek professional guidance to ensure compliance with tax laws and Accounting standards.

2. Create a Journal Entry: If advised, producing a journal entry to move liabilities to expenses could be an effective solution. This would help rectify the negative balance while accurately reflecting the company’s financial activities.

3. Monitor Financial Statements: After the adjustment, keep a close eye