Deceased employee W2 amendment created negative payroll liability – Help?

Navigating Payroll Challenges After the Loss of an Employee: A Case Study

The unexpected loss of an employee is a challenging time for any organization, not only emotionally but also from a logistical standpoint, especially when it comes to payroll management. A recent situation has surfaced that highlights the complexities encountered after the passing of an employee, particularly regarding W-2 forms and the associated liabilities.

The Situation

In late December 2023, a key company owner sadly passed away. Despite their death occurring at the end of the calendar year, the employee received a paycheck during the subsequent pay period in 2024. This paycheck included deductions for their 401(k) loan and standard withholdings. Later, a W-2 was issued for this individual at the end of January 2024—a practice generally deemed improper for deceased employees.

As I had not yet joined the organization at the time of these events, I had to navigate this situation during the estate’s tax filing process. To resolve the issues surrounding the deceased employee’s tax obligations, I solicited the payroll service provider to amend the W-2 and to issue a 1099 instead.

This amendment initiated a journal entry from the payroll service that resulted in negative balances in both the loan and withholding liability accounts. Typically, the next step would involve the business refunding these amounts to the employee’s estate. However, due to the significant time lapse between the employee’s passing and the tax filing, the estate had already transferred funds from the employee’s 401(k) into a different account, inadvertently affecting the loan payment and standard withholdings.

Seeking a Resolution

Now, we face the question: How can we rectify this issue? One potential solution involves making a journal entry that reallocates amounts from the payroll liabilities to payroll expenses. This step could potentially clear the negative liability, but it raises crucial considerations regarding the overall impact on the balance sheet.

Key Considerations

1. Implications for Accuracy: Adjusting payroll liabilities by shifting them to expenses may resolve the immediate negative balance, but it’s essential to ensure that this adjustment aligns with financial reporting standards.

2. Long-term Impact: Understanding how this adjustment impacts the balance sheet is vital. While it might eliminate negative figures in the short term, it could introduce complexities in future reporting and financial accuracy if not handled correctly.

3. Consultation with Professionals: Given the intricacies surrounding payroll during such sensitive circumstances, it may be prudent to consult