Deceased employee W2 amendment created negative payroll liability – Help?

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

The abrupt passing of a valued team member is a heart-wrenching experience that also brings about complex administrative challenges. This case highlights a situation where the death of an employee led to payroll discrepancies, specifically concerning W-2 corrections and the accounts affected within a company’s liability framework.

The Scenario

In late December 2023, we faced the untimely loss of one of our company owners. Notably, the final payday for the corresponding payroll period extended into January 2024, resulting in the issuance of a paycheck that included deductions for a 401(k) loan and standard withholdings. To complicate matters, a W-2 was issued for the deceased individual at the end of January 2024, which, according to IRS guidelines, is improper for a deceased employee.

Upon discovering this error while assisting in the 2023 tax filing for the deceased’s estate, I coordinated with our payroll service provider to amend the W-2 and prepare a 1099 instead. However, this amendment triggered a journal entry (JE) that inadvertently established a negative liability in both the loan and withholding accounts.

The Conundrum

Typically, one would expect that the company could subsequently return any erroneous withholdings to the estate. Nonetheless, due to the elapsed time between the employee’s death and the tax filings, the estate had reallocated funds from the individual’s 401(k) accounts, complicating the process further as both loan payments and standard deductions were affected.

This situation leads to an important question: how do we rectify the negative liability that has arisen in our books?

Seeking Solutions

One potential remedy could involve creating a journal entry to reassign the negative amounts from the payroll liability accounts to payroll expenses. However, this prompts further inquiry regarding the broader implications on our balance sheet. Specifically, aside from resolving the negative liability, what other effects will this adjustment incur?

Possible Action Steps

1. Consult a Payroll Specialist: Engaging with a professional who understands both payroll compliance and tax law can give you a clearer understanding of the permissible actions to take.

2. Adjust Journal Entries: Moving liabilities to payroll expenses could be a viable solution. However, it’s crucial to understand that this would impact your retained earnings and overall financial reporting.

3. Establish Communication with the Estate: If applicable, liaise with the estate’s representatives regarding any potential refunds or