Final Payments Present Federal, State Pitfalls

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Payroll processing for a deceased employee’s final wages may be complicated by federal and state requirements, payroll training directors said May 18 at the American Payroll Association’s Congress in National Harbor, Md.

As a basic rule, employers must not assume that they are to issue the payment to the employee’s estate because an estate may not exist, said Sally Thomson, CPP, director of payroll training at the American Payroll Association.

The payroll department also should update its payroll system to terminate the employee’s employment, said Linda Dailey, CPP, director of payroll of the American Public University system. 

The final payment may not be made through the payroll system, Dailey said, noting that the final payment must go to a beneficiary as determined by state law. 

The employer should obtain a Form W-9, Request for Taxpayer Identification Number and Certification, for the beneficiary, rather than use the employee’s Social Security number, Dailey said. 

Although the form is not required, the beneficiary must have a valid taxpayer identification or Social Security number or else the backup withholding rate of 24 percent must be used, Thomson said.

Payroll should suspend direct deposit and determine if the employee had any uncashed paychecks, Dailey said. The value of any stock options also should be determined as of the date of death, she said.

Issuing and Taxing Payments

If a deceased employee has wages payable during the same calendar year, such as accrued payments or time off, a Form W-2, Wage and Tax Statement, and 1099-MISC must be issued, Thomson said. 

The wages must go in the W-2’s Boxes 3 through 6 and no federal income tax should be withheld, she said, noting that the payment is subject to other federal taxes and possibly state unemployment insurance tax. The beneficiary is sent a Form 1099-MISC in their name that reports the gross amount of the payment, Thomson said. 

If the wages are payable in the next calendar year, no Form W-2 is issued and the beneficiary is sent a Form 1099-MISC in their name, Thomson said.

If an employee who did not use direct deposit passes away before cashing a paycheck, the net pay should be reissued to the beneficiary and reported on a Form W-2, she said.

Private employers should withhold all federal taxes from the payment, but public employers may have an agreement to provide Social Security and Medicare to employees, Thomson said. The employer should follow the state law where the employee lived, which provides for the maximum amount payable and to whom it is payable, she said.

Most states follow federal rules for withholding on final payments or do not require withholding, Thomson said. In Hawaii, back wages are not subject to withholding, and in New Jersey and Oregon withholding is required on wages that were earned but unpaid at the time of death, she said. 

Seventeen states have no provisions for issuing or taxing final payments, requiring employers to create their own policies, Thomson said. Eighteen states have provisions for a maximum payment, and seventeen states have no maximum, she said.