A common error made by employers is to report payments made after the death of an employee on a W-2 withholding SS and Medicare taxes. Per the IRS’s W-2/W-3 Instructions (page 8), payments should be reported as follows:
Payment made after death but in the year of death – Withhold SS and Medicare taxes and only report the income in boxes 3 and 5 to ensure proper Social Security and Medicare credit was received. Do not show the payment in box 1. Also, issue a 1099-MISC and report the payment in box 3 for payment to the estate or beneficiary.
Payment made after the year of death – Do not report it on Form W-2. Also, issue a 1099-MISC and report the payment in Box 3 for payment to the estate or beneficiary.
As you can see, when an employer makes payments in the year after the death and reports the income on a W-2, the employer will mistakenly pay and withhold Social Security and Medicare taxes when the employer should have simply issued a 1099-MISC with income in box 3.
When this occurs, the correct thing to do would be to have the employer amend the W-2 to no W-2, refund the taxpayer all of the withholding, and issue a 1099-MISC. No doubt some employer will be reluctant to do all that, especially after the 1099 and W-2 due dates. A workaround is to forego the SS and Medicare taxes and report the W-2 on a 1041.