Navigating Payroll Challenges Following the Passing of an Employee: A Guide

The passing of an employee is a difficult, emotional experience for any organization. However, when it comes to payroll processing during such times, complications can arise that create challenges for Accounting departments. One particular case has brought forward questions regarding the handling of W-2 forms and payroll liabilities for deceased employees—a situation that warrants further exploration.

The Situation: A Deceased Employee’s Payroll Complications

At the end of December 2023, one of the company owners unfortunately passed away. Coincidentally, payday for that pay period fell in early January 2024, during which a paycheck was issued, complete with deductions for a 401(k) loan and standard payroll withholdings. As is standard practice, a W-2 was prepared for the deceased employee and distributed at the end of January 2024. However, this situation is not in accordance with IRS guidelines, as a W-2 should not be issued for an employee who has passed.

As a result of the oversight, the payroll service provider had to amend the original W-2 after the estate of the deceased filed taxes. This led to the issuance of a 1099 instead, but complications did not end there. The amendment process generated a journal entry (JE) resulting in a negative liability in both the loan and withholding liability accounts.

Understanding the Implications

It’s common practice for a business to issue a refund to the deceased employee’s estate to rectify discrepancies related to deductions. However, in this instance, significant time had lapsed between the employee’s death and the tax filing, during which the estate had already transferred funds from the employee’s 401(k) into another account. Consequently, the loan payment and regular withholding amounts were also moved, complicating matters further.

Addressing the Negative Liability

The question remains: how can these Accounting challenges be effectively resolved? A straightforward approach would involve creating a journal entry to transfer amounts from payroll liabilities into payroll expenses—an action aimed at alleviating the negative liability. But this raises important considerations about the impact of this change on your company’s financial statements.

The Path Forward

1. Ensure Accurate Documentation: Before making any adjustments, ensure that all documentation regarding the deceased employee’s payroll activities and the estate’s tax filings is thoroughly reviewed.

2. Create a Journal Entry: If transferring amounts from payroll liabilities to payroll expenses is deemed necessary, accurately document the journal entry