Navigating Payroll Challenges After the Loss of an Employee

Losing an employee is never easy, and the complexities involved in managing payroll and tax obligations can add to the burden. A recent situation faced by one business sheds light on potential pitfalls when a company experiences the death of an employee during a pay period.

The Situation

At the end of December 2023, one of the company’s owners tragically passed away. Coinciding with this, the pay schedule for the final pay period took place in 2024. Unfortunately, a paycheck was issued that included deductions for both a 401(k) loan payment and regular withholdings. Following this, a W-2 form was generated for the deceased employee at the end of January 2024, which raises significant questions about compliance with tax regulations concerning deceased individuals.

The Complications

During the processing of the deceased employee’s 2023 tax return, which was handled by the estate, a request was made to the payroll service provider to amend the W-2 and provide a 1099 instead. This amendment led to an adjusting journal entry (JE) from the payroll service, resulting in a negative liability balance in both the loan and paycheck withholding accounts.

Under typical circumstances, these negative liabilities would be addressed through a refund to the estate. However, due to the extensive time lapse between the employee’s passing and the tax filings, the estate had already reallocated funds from the deceased’s 401(k) accounts, complicating matters further as well as the status of the deductions.

Finding a Solution

The pressing question now is how to resolve these outstanding discrepancies. Is it feasible to create a journal entry that transfers the amounts from payroll liabilities into payroll expenses? This could potentially rectify the negative liability, but it’s essential to consider the implications for the balance sheet.

Potential Steps to Take

1. Review the Journal Entries: Start by auditing the JEs to ensure accurate reflection of the transactions related to the deceased employee.

2. Consult with the Payroll Service Provider: Engage with your payroll company to understand their procedures and receive guidance on properly categorizing the adjustments.

3. Adjust the Liabilities: If it is determined that moving these amounts from payroll liabilities to payroll expenses is the correct course of action, document this process carefully and assess its impact on your balance sheet. Although it would address the negative liabilities on record, it will also affect your reported expenses.

4. **Seek Professional