Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Challenges Following the Death of an Employee

Introduction

Handling payroll and tax obligations can be complex, especially in the unfortunate event that an employee passes away. A recent dilemma surfaced involving the necessary adjustments made to a deceased employee’s W-2, which inadvertently led to some negative liabilities within the payroll accounts. Below, we’ll explore this issue, the steps taken, and potential resolutions for those who might find themselves in a similar situation.

The Situation Unfolds

In December 2023, a pivotal member of the company passed away, a circumstance that became especially complicated when the payroll processing for that period extended into 2024. During this time, the deceased was still recorded as receiving a paycheck, which included deductions for a 401(k) loan and other regular withholdings. At the end of January 2024, the payroll service issued a W-2 for this employee, a practice that generally should not occur for someone who has passed.

While the details of this incident were not known to me at the time, it became crucial to address this irregularity as part of the estate’s tax filings. I requested the payroll service provider to amend the W-2, resulting in the necessity to issue a 1099 instead.

The Consequence of the Amendment

The W-2 amendment initiated a journal entry (JE) from the payroll service, creating a negative balance in both the loan and withholding liability accounts. Typically, the expected procedure would involve the business refunding the appropriate amounts back to the deceased employee’s estate. However, significant time had passed since the employee’s death, and the estate had already transferred funds from his 401(k) accounts. This action further complicated the matter, as the associated loan payments and withholdings also moved out of the original accounts.

Seeking a Resolution

Now left with negative liabilities in the books, the pressing question is: how can this be rectified? One potential solution would involve creating a journal entry to transfer those negative amounts from the liability accounts to payroll expenses. But it’s crucial to understand the implications of this approach on the company’s balance sheet.

Understanding the Impact

1. Clearing Negative Liabilities: By addressing the negative balance through a journal entry, the accounts will reflect accurate liabilities, thus easing any discrepancies in payroll reporting.

2. Expense Recognition: Moving amounts to payroll expenses may influence the company’s financial statements, increasing expenses and potentially affecting profitability. It’s vital to consider