Deceased employee W2 amendment created negative payroll liability – Help?

Resolving Payroll Liabilities for a Deceased Employee: A Guide

Navigating payroll and tax issues after the passing of an employee can be a complex and challenging endeavor. This is particularly true in the case of an employee who died at the end of a tax year and received compensation posthumously. In this blog post, we will explore a specific scenario in which a deceased employee’s W-2 amendment resulted in negative payroll liabilities, and how to rectify these issues.

Background Context

Recently, a business faced a complicated situation when one of its owners passed away at the end of December 2023. The last paycheck, which was processed in January 2024, included deductions for a 401(k) loan and standard withholdings. However, the issuance of a W-2 for a deceased individual, which is generally disallowed, further complicated matters.

Subsequent to the employee’s passing, the estate initiated tax filings, requiring amendments to the payroll records. Consequently, the payroll service provider was asked to modify the original W-2 and issue a 1099 to accurately reflect the situation. This amendment inadvertently created journal entries that resulted in negative liabilities in the accounts associated with the loan and withholdings.

Understanding the Implications

Typically, under more normal circumstances, the company would return any excess amounts back to the estate of the deceased employee as part of rectifying the payroll liabilities. However, due to the significant delay in resolving these issues, the estate has since transferred funds from the employee’s 401(k) accounts to another account, leading to further complications with the loan payments and withholdings.

Steps to Address the Issue

If you find yourself in a similar situation, here’s how you can approach fixing the negative payroll liabilities:

1. Review Journal Entries: First, check the journal entries created as a result of the W-2 amendment. Understanding these entries will help you identify their impact on your financial records.

2. Create Adjusting Journal Entries: If it’s determined that the original entries were incorrect, you may need to create adjusting entries to move amounts from payroll liabilities to payroll expenses. This would help eliminate the negative liability status.

3. Consequences on Financial Statements: It’s essential to evaluate how these adjustments will affect your balance sheet. While the primary goal is to clear the negative liabilities, you should also consider the implications on overall payroll expenses and report adjustments accurately.

4. Consult a Professional