Navigating Payroll Liabilities After the Passing of an Employee: A Guide to W-2 Amendments

The unfortunate passing of an employee can lead to several complexities in payroll Accounting, particularly when it comes to handling their final wages and tax documents. In this post, we’ll explore a scenario where an employee passed away at the end of December 2023, sparking confusion around W-2 forms and payroll liabilities. Additionally, we’ll discuss how to address the payroll issues that may arise in such situations.

Background of the Situation

Tragically, one of the company’s owners passed away just as the year was concluding. The timing created complications since the final paycheck was issued in January 2024, which included both a 401(k) loan payment and standard tax deductions. Consequently, the company produced a W-2 for the deceased employee at the end of January 2024—a practice that is generally not permissible.

As I wasn’t part of the team during this unfortunate event, I found myself in the position of needing to rectify matters when it came time to file the deceased’s 2023 taxes through the estate. This required reaching out to our payroll service provider to amend the W-2 and issue a 1099 instead, reflecting the employee’s passing more accurately.

The Complication: Negative Payroll Liabilities

After the W-2 amendment, our payroll service generated a journal entry that unexpectedly resulted in a negative balance within both our loan and withholding liability accounts. Typically, in more prompt scenarios, companies would refund the relevant amounts back to the estate. However, due to the significant delay between the employee’s death and the tax filing, the estate had already transferred funds from the deceased’s 401(k) into another account. This meant that the loan payment and standard deductions ceased to exist in the original account.

Addressing the Issue

Now, the pressing question is: how can we resolve the negative payroll liability? One suggested approach is to make a journal entry to shift those negative amounts from the payroll liability accounts to payroll expenses.

Understanding the Impact

1. Clearing Negative Liabilities: Moving these amounts will effectively eliminate the negative figures that currently distort the accuracy of our company’s financial statements.

2. Balance Sheet Considerations: While this adjustment clears the negative liability, it will also reduce our overall liabilities and increase our payroll expenses. This could potentially impact profit margins, so it’s important to assess how this will affect our financial standing.