EMPLOYER MUST REPORT ACCRUED WAGES AND VACATION PAY WHICH ARE INCOME IN RESPECT OF DECEDENT ON FORM 1099-MISC, DEATH BENEFITS ON FORM 1099R

Rev. Rul. 86-109

ISSUE

(1) How must the former employer of a deceased employee report payments of the employee's accrued wages and vacation pay that are made to the estate of the employee or to a person who acquired the right to receive the payment?

(2) How must such an employer report payments of death benefits made to the employee's estate or to a person who acquired the right to receive the payments solely because of the death of the employee?

FACTS

Before A's death on April 25, 1984, A was employed by X, a corporation, and was paid on a monthly basis. From January 1 to April 1, 1984, A received $12,000 in wages, When A died, X owed A $3,000 in wages and $2,000 in accrued vacation pay, all of which X paid to A's estate. During 1984 X also paid $8,000 in death benefits to A's estate. The death benefits were paid under a plan that qualified under section 403 of the Internal Revenue Code and that had been established by X for all of its employees. The benefits were not amounts for which A possessed a nonforfeitable right while living, but were paid solely by reason of A's death.

LAW AND ANALYSIS

ISSUE 1

Under section 6051(a) of the Code, every person required to deduct and withhold from an employee a tax under section 3101, relating to the Federal Insurance Contributions Act (FICA), or section 3402, relating to income tax, must furnish to each such employee a written statement showing certain information with respect to the remuneration paid by that person to the employee during the calendar year. The statement must be furnished on or before January 31 of the succeeding year, or, if the employment is terminated before the close of the calendar year, within 30 days after the date of receipt of a written request from the employee if the 30-day period ends before January 31.

Section 691(a)(1) of the Code provides as a general rule that the amount of all items of gross income in respect of a decedent that are not properly includible in the taxable period in which the decedent died or a prior period (including the amount of all items of gross income in respect of a prior decedent, if the right to receive the amount was acquired by reason of the death of the prior decedent) must be included in the gross income for the taxable year when received, of: (A) the estate of the decedent, if the right to receive the amount is acquired by the decedent's estate from the decedent; (B) the person who by reason of the death of the decedent acquires the right to receive the amount, if the right to receive the amount is not acquired by the decedent's estate from the decedent; or (C) the person who acquires from the decedent the right to receive the amount by bequest, devise, or inheritance, if the amount is received after a distribution by the decedent's estate of such right.

Section 691(a)(3) of the Code provides that income in respect of a decedent is considered to have the same character in the hands of the recipient that it would have had in the hands of the decedent had the decedent received such amount while alive.

Under section 3121(a) of the Code, the term "wages" for purposes of the FICA means, with certain exceptions, all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash. Section 3401(a), relating to the withholding of income tax, contains a similar definition.

Section 1.6041-2(a)(1) of the Income Tax Regulations provides that wages, as defined in section 3401 of the Code, paid to an employee are to be reported on Form W-2.

Rev. Rul. 55-229, 1955-1 C.B. 75, concerns a lump sum payment representing accrued annual leave that was earned by a federal government employee and that is payable upon separation from the government. The ruling holds that this payment represents compensation for services rendered. The death of the employee and the receipt of the payment by a beneficiary of the employee does not change the nature and identity of the payment. Thus, under the provisions of section 691(a) of the Code, the payment is includible in the gross income of the beneficiary or estate.

Rev. Rul. 64-150, 1964-1 (Part 1) C.B. 448, states that under the general rule provided in section 691(a)(1) of the Code, the entire amount of salary earned by an employee, but unpaid at death, is income in respect of a decedent and is includible in the gross income of the recipient for the taxable year in which it is received. The amount includible as income in respect of a decedent is not reduced by any FICA withholding or other reduction required to be made from the entire salary earned. Under Rev. Rul. 64-150 an employer is required under section 6041(a) to report on Form 1099, accompanied by Form 1096, the total amount of salary, if $600 or more, unreduced by the amount of any deductions, even though only the net amount is actually paid to the deceased employee's estate or beneficiary.

Rev. Rul. 71-456, 1971-2 C.B. 354, concerns death benefits, and amounts representing regular compensation earned immediately preceding death but unpaid at the time of death, paid to beneficiaries and to the estates of deceased employees. The ruling holds that wages for purposes of the collection of income tax at source do not include these amounts but that wages for purposes of the FICA tax include amounts representing regular compensation that was earned immediately preceding death but was unpaid at the time of death and that are paid by an employer to a survivor of a former employee.

Subsequent to publication of Rev. Rul. 71-456, paragraph (14) was added to section 3121(a) of the Code, effective in the case of any payment made after December 1972. Section 3121(a)(14) excepts from the definition of wages, for FICA purposes only, payments by an employer to a survivor or the estate of a former employee made after the calendar year in which the employee died. Payments to a survivor before the close of the calendar year in which the employee died are subject to FICA.

In the present situation, X made payments to A's estate before the close of the calendar year and, thus, the payments are subject to FICA tax. To ensure that A receives proper social security credit, the $5,000 in wages and accrued vacation pay earned by A prior to death but paid to A's estate after A's death should be included with the $12,000 paid before A's death in Box 13, social security wages, of A's final Form W-2. However, only $12,000 is taxable to A and should appear in Box 10, Wages, tips, other compensation.

The $5,000 in accrued wages and vacation pay that were paid to A's estate are taxable to the estate. Under Rev. Rul. 64-150, all amounts earned but unpaid at an employee's death received by an estate or beneficiary of a deceased employee should be reported on Forms 1099 and 1096. Thus, the $5,000 paid to A's estate should be reported on Form 1099 MISC, Statement for Recipients of Miscellaneous Income, as non-employee compensation.

ISSUE 2

Under section 101(b) of the Code, gross income does not include amounts received, not to exceed $5,000 (whether in a single sum or otherwise), by the beneficiaries of the estate of an employee, if the amounts are paid by or on behalf of an employer and are paid by reason of the death of the employee.

Section 3121(a)(13) of the Code excepts from the definition of wages for FICA purposes any payment or series of payments by an employer to an employee, or any dependent of the employee, that is paid (A) upon or after the termination of the employee's employment relationship because of death or retirement for disability, and (B) under a plan established by the employer that makes provisions for employees generally or a class or classes of employees. This provision does not apply to any payment or series of payments that would have been made if the employment relationship had not been so terminated. The definition of wages under section 3401 for purposes of income tax withholding does not contain an exemption that is similar to the exception in section 3121(a)(13).

Section 1.6041-2(b)(1) of the regulations provides that amounts (i) which are distributed or made available to a beneficiary, and to which section 402 of the Code (relating to employee trusts) or section 403 (relating to employer annuity plans) applies, or (ii) which are described in section 72(m)(3)(B) (relating to life insurance contracts) must be reported on Forms 1099, Statement for Recipients, and 1096. Annual Summary and Transmittal of U.S. Information Returns, to the extent that such payments are includible in the gross income of the beneficiary if the amounts so includible aggregate $600 or more in any calendar year.

Thus, unlike the amounts discussed in Issue 1, the death benefits are not wages for purposes of the FICA tax. Death benefits paid from a qualified plan are amounts paid solely by reason of the employee's death for which the employee did not possess a nonforfeitable right while living. They are reported on Form 1099R, Statement for Recipients of Total Distributions from Profit-Sharing, Retirement Plans, Individual Retirement Arrangements, Etc. The entire $8,000 in death benefits from a qualified plan paid by X to A's estate should appear on Form 1099R, even though the recipient beneficiaries may exclude up to $5,000 from income as death benefits under section 101(b) of the Code.

HOLDING

ISSUE 1: Accrued wages and vacation pay of a deceased employee paid to an estate, or other person who has acquired the right to receive the payments, are reported on Form 1099-MISC. These payments are not considered wages for purposes of the collection of income tax at source and thus they do not appear in Box 10, Wages, tips, other compensation, of A's final Form W-2. They are not considered wages for FICA purposes unless paid to the survivor or estate before the close of the calendar year in which the employee died. If they are paid before that date, the total amount of the payments appears in Box 13, Social security wages, of A's final Form W-2, even though it does not appear in Box 10.

ISSUE 2: The entire amount of death benefits from a qualified plan paid to an estate, or other person who has acquired the right to receive the payments solely because of the death of the employee, should be reported on Form 1099R even though up to $5,000 may be exempt from income tax as death benefits under section 101(b) of the Code. The death benefits of $8,000 paid to A's estate are reported on Form 1099R issued to A's estate.

Death benefit payments from a nonqualified plan are also reported on Form 1099R.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 64-150 is clarified and, as clarified, is superseded.

Rev. Rul. 71-456 is modified and, as modified, is superseded.