The death of an employee is not something we like to think about and can be a very difficult and confusing scenario for all coworkers involved. However, something often pushed to the side is the administrative tasks and what must be done to ensure the employee’s wages are handled properly. Although it may be an uncomfortable topic to think about now, being prepared will make the potential situation less complicated to handle in the future.
The payroll department needs to be informed of the death as soon as possible, they need to freeze all wages until proper documentation has been received (i.e. death certificate and form W-9 for beneficiary or estate). After the death has been reported, the following issues need to be handled.
Deceased employee’s wages - Instructions from IRS Form 1099
If an employee dies during the year, the accrued wages, vacation pay, and other compensation paid after the date of death must be reported. If the payment was made in the same year the employee passed, you must withhold social security and Medicare taxes on the payment and report them only as social security and Medicare wages on the employee’s Form W-2. This ensures that proper social security and Medicare credit is received.
On the Form W-2, show the payment as social security wages (box 3), Medicare wages and tips (box 5) and the social security and Medicare taxes withheld (boxes 4 and 6). You do not need to not show the payment in box 1 of Form W-2.
If you made the payment after the year of death, do not report it on Form W-2, and do not withhold social security and Medicare taxes.
Whether the payment is made in the year of death or after the year of death, you also must report the payment to the estate or beneficiary on Form 1099-MISC. Report the payment in box 3 (rather than in box 7 as specified in Rev. Rul. 86-109, 1986-2 C.B. 196).
Enter the name and TIN of the payment recipient on Form 1099-MISC. For example, if the recipient is an individual beneficiary, enter the name and social security number of the individual; if the recipient is the estate, enter the name and employer identification number of the estate. The general backup withholding rules apply to this payment.
Example of Payments and Withheld Wages
Before Employee A’s death on June 15, 2012, A was employed by Employer X and received $10,000 in wages. From those wages, $1,500 of federal income tax was withheld.
When A died, X owed A $2,000 in wages and $1,000 in accrued vacation pay. The total of $3,000 (less the social security and Medicare taxes withheld) was paid to A’s estate on July 20, 2012.
Because X made the payment during the year of death, X must withhold social security and Medicare taxes on the $3,000 payment and must complete Form W-2 as follows.
- Box 1—$10,000.00 (does not include the $3,000 accrued wages and vacation pay)
- Box 2—$1,500.00
- Box 3—$13,000.00 (includes the $3,000 accrued wages and vacation pay)
- Box 4—Social security tax withheld on the amount in box 3
- Box 5—$13,000.00 (includes the $3,000 accrued wages and vacation pay)
- Box 6—Medicare tax withheld on the amount in box 5
Employer X also must complete Form 1099-MISC as follows.
- Boxes for recipient’s name, address, and TIN—the estate’s name, address, and TIN.
- Box 3—3000.00 (Even though amounts were withheld for social security and Medicare taxes, the gross amount is reported here.)
If Employer X made the payment after the year of death, the $3,000 would not be subject to social security and Medicare taxes and would not be shown on Form W-2. However, the employer would still file Form 1099-MISC.
Special Rules for Various Types of Services and Payments (IRS Circular E)
Most states have the same taxability of deceased employee wage payments, but make sure to confirm your specific state’s law of deceased employees. If final wage payment is made after calendar year of worker’s death, the wages are not taxable for state income tax or state unemployment tax.
Local income taxes for the employee will vary. There are localities that the taxable wages must be the same as the Medicare wages. In these cases, the wages would be taxable for local but not for federal or state income tax. If final wage payment is made after the calendar year of worker’s death, the wages are not taxable as there are no Medicare wages.