Payroll in Practice: 3.17.2025

Question: An employee died shortly before the end of the year. All compensation paid to the employee during the year was included in the employee’s Form W-2. In the first quarter of the current year, the employer will pay the decedent’s accrued wages, vacation pay, and annual bonus to the surviving spouse, who is an employee at the same company. Should the amount paid to the surviving spouse be reported on Form W-2 or Form 1099-MISC?

Answer: The accrued wages, vacation pay, and bonus are all compensation earned by the decedent, not the spouse. Compensation actually paid or constructively received by the employee before death is included in the decedent’s Form W-2, Wage and Tax Statement, for all tax purposes. Even though the surviving spouse is an employee, accrued amounts that were not constructively received prior to the time of death are reported on Form 1099-MISC, Miscellaneous Information.

Constructive receipt is a cash-basis concept that determines when cash is received for tax reporting purposes. An employee is deemed to have received a wage payment when the employer makes the funds available to the employee. Courts have interpreted this to include funds in a paycheck or direct deposit that are available to or mailed to an employee on a scheduled date before death, even if they are not received by the employee on that date.

Compensation not paid or constructively received by the former employee before death are “wages in respect of a decedent,” which refers to wages and compensation earned by the decedent that were not set aside in cash for payment to the employee at the time of death. Examples include accrued wages, commissions, and accrued benefits such as vacation pay and bonuses.

Wages in respect of a decedent are paid to the estate or to an appropriate person such as a personal representative, executor, or designated beneficiary. The employer must obtain a tax ID number from the designated payee, usually on Form W-9, Request for Taxpayer Identification Number and Certification. Constructively received wages may also end up being paid to an appropriate person. But regardless of who receives the payment, the wages are reported on the decedent’s Form W-2 for income tax purposes and are taxable to the decedent in the year the decedent died. They are not reported as taxable income to the payee.

If the payee distributes the wages in respect of the decedent to other beneficiaries, the payee may need to issue nominee information returns. For example, an estate would issue a Schedule K-1 (Form 1041), Beneficiary’s Share of Income, Deductions, Credits, etc., to each beneficiary who received a share of the income from the estate. An individual payee, such as a personal representative or beneficiary, may have to issue Forms 1099-MISC to beneficiaries that received funds from the payee.

The reporting becomes complicated for income tax purposes because the wages are taxable to whoever receives the payment. The wages are reportable on the decedent’s tax return if actually or constructively received before death but are taxable to the recipient if the wages had not been actually or constructively received by the late employee before death.

IRS Publication 559, Survivors, Executors, and Administrators, and the General Instructions for Forms W-2 and W-3 have additional information on how to handle wages involving a deceased employee.

With respect to the payee in this case, the payment of the accrued benefits will be made in the year after the employee died. The payment is considered income in respect of the deceased employee. While the payment is subject to income tax, it is exempt from income tax withholding, because it is made to a beneficiary of the deceased employee.

Because the beneficiary also works for the employer in this case, the employer has a tax ID for the beneficiary. However, it is still good practice to obtain a Form W-9 from the beneficiary for compliance documentation purposes. The Form W-9 documents that the employer has done the required due diligence with regard to reporting the payment and is not required to backup withhold income tax from the payment.

For income tax purposes, the wages in respect of the decedent are not included the deceased employee’s Form W-2 and income taxes are not withheld. Instead, the wages are paid to the beneficiary and reported on Form 1099-MISC in Box 3 as income in respect of a deceased employee. The beneficiary is responsible for reporting the income on his or her individual tax return or issuing appropriate nominee information returns to the ultimate beneficiaries.

The payment to the beneficiary should not be processed through payroll because the payment is not wages earned by or paid to the beneficiary. The Social Security, Medicare and FUTA wages associated with the payment should not be credited to the beneficiary’s SSA or FUTA accounts. State laws should be checked to determine whether state taxes should be withheld.

Because the payment is made after the year of death, it is exempt from FICA and FUTA taxes. For federal tax purposes, no Form W-2 is required. However, if the payment had been made in the year the employee died, the payment would be subject to FICA and FUTA taxes, and the Social Security and Medicare wages and taxes would be reported on the deceased employee’s Form W-2 for that year.

This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., or its owners.

Author Information
Patrick Haggerty is the owner of a tax practice in Chapel Hill, North Carolina, and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

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