Navigating Payroll Liabilities After a Deceased Employee’s W-2 Amendment: A Guide

Managing payroll can be challenging under typical circumstances, but when an employee passes away, the situation can become even more complex. A recent issue faced by one company illustrates the potential pitfalls in handling payroll for a deceased employee and the resulting complications with tax filings.

The Situation

In December 2023, one of the company owners sadly passed away. The payday for that final pay period occurred in 2024, during which a paycheck was issued that included deductions for regular payroll taxes and a 401(k) loan payment. By the end of January 2024, a W-2 form was generated for the deceased employee, leading to complications, as such a form is typically not permissible for individuals who have died.

Since the individual was not involved in the payroll processes at the time, the responsibility fell on another team member to rectify the situation. They contacted the payroll service, requesting an amendment to the W-2 and the issuance of a 1099 instead, to comply with tax regulations concerning deceased employees.

However, this W-2 amendment resulted in a journal entry from the payroll service that generated negative liabilities in the accounts related to loan payments and withholding. In typical circumstances, businesses should refund any overpayments to the estate of the deceased. Yet, in this case, the estate had already transferred the funds from the employee’s 401(k) accounts, complicating matters further.

Resolving the Issue

Now, the question arises: how can one rectify the negative liabilities created by the amendment of the W-2? The proposed solution involves creating a journal entry (JE) that reassigns the amounts from payroll liabilities to payroll expenses.

Key Considerations

1. Making the Journal Entry: This solution may appear straightforward; however, thorough Accounting principles must be followed to ensure that all changes are documented accurately.

2. Impact on Financial Statements: Moving these amounts from payroll liabilities to payroll expenses may effectively clear the negative liability, but it’s crucial to understand the ramifications on the balance sheet. Such a change will alter the company’s overall financial picture. The negative liabilities may disappear, but they will need to be reported as part of the operating expenses going forward, affecting net income and potentially impacting taxation.

3. Consulting with Professionals: Given the complexities involved in payroll and tax related to deceased employees, it’s wise to consult with an Accounting professional or a tax