Charles Read, CPA, USTCP, IRSAC
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The loss of an employee due to death is a difficult time for a business. Not only is it hard to lose a friend and colleague, but the business is faced with the need to hire and train a replacement, a loss of productivity, and potentially complicated legal issues.
One of these issues involves how to properly handle any wages that are due to a deceased employee.
There are several factors that determine whether or not the payment of that employee’s wages are taxable, how the payments and taxes withheld should be reported, and to whom the wages should be paid.
These factors include the following:
- Whether the payment is for an uncashed paycheck or for unpaid accrued wages, vacation pay, taxable fringe benefits, or other types of accrued compensation.
- Whether the payments are made in the same year the employee died or in the following year.
- Whether or not there are state laws limiting the amount that can be paid, to whom the wages can be paid, and whether or not state income taxes should be withheld.
Handling a Deceased Employee’s Paycheck
If a paycheck has already been issued to an employee, but the employee dies before cashing it, a check has to be reissued for the same net amount of the original check, payable to the employee’s beneficiary or personal representative.
The employer should also have the employee’s personal representative sign a statement that the money being paid is for a deceased employee’s uncashed paycheck. Since the final paycheck was already issued once, the necessary taxes have already been withheld, so the wages and taxes will be reported on the employee’s Form W-2 at the end of the year.
One issue that must be addressed at this point is the definition of the personal representative. Under federal law, an employee’s personal representative is any person designated by an employee’s will or determined by probate. If there is no will or if the employee’s will or estate has not yet been probated, the check should be issued to the employee’s estate.
Employers will want to check state law at this point, because it may designate that only certain individuals (such as a spouse, children, or parents) may be the employee’s personal representative, and may limit how much may be paid directly to a personal representative.
Accrued Wages Paid the Same Year as the Employee’s Death
Before a deceased employee’s accrued wages can be paid, the employer should have the employee’s personal representative or beneficiary complete a Form W-9 in order to obtain the person’s Social Security number (SSN). Typically, if there is no personal representative, then the wages cannot be paid until the probate court has established the estate and the IRS has issued a tax identification number (TIN) for the employee’s estate.
Wages paid in the year the employee died are subject to federal employment taxes (Social Security, Medicare, and FUTA). Therefore, the employer must withhold the Social Security and Medicare taxes from the employee’s unpaid wages and deposit these taxes and the employer’s share. [IRS Publication 15, pp. 23, 36.] At the end of the year the wages will be included on Form 940, subject to the FUTA tax. The employer will report the accrued wages and the federal employment taxes withheld in Boxes 3-6 on the employee’s Form W-2. The gross amount of the unpaid wages should not be included in Box 1. [IRS Revenue Ruling 86-109.] The gross amount paid should be reported in Box 3 (other income) of Form 1099-MISC in the name and TIN of the beneficiary, personal representative, or the employee’s estate (see www.irs.gov/pub/irs-pdf/i1099msc.pdf).
Wages Paid in a Year after the Employee’s Death
The payment of accrued wages may not be paid until a later year because of delays in probating the employee’s estate. When this happens, IRS Revenue Ruling 86-109 states that “these payments are not considered wages for purposes of the collection of income tax at source,” and the payments are not subject to federal employment taxes. These amounts will not be reported on a Form W-2.
Therefore, the employer will report the gross amount paid in Box 3 (other income) of Form 1099-MISC in the name and TIN of the beneficiary, personal representative, or the employee’s estate.
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