Legal Considerations When an Employee Dies

ranta_legal issues when an employee dies November 16, 2020 By: Keith Ranta and Julia E. Judish

While you will surely look for ways to support a deceased employee’s family and coworkers, you will also need to attend to employment-related legal matters to ensure that the estate or beneficiaries receive what they should and the association is protected from liability.

The sudden, unexpected death of an employee can be devastating and confusing to an association and its workforce. Employers often want to immediately help the employee’s family financially in this time of grief, but a number of administrative, legal, and tax-related issues must be considered before the organization pays final compensation and benefits to the beneficiaries or estate of the deceased employee.

Final Salary and Accrued PTO

Employers must consider state law requirements when paying final compensation to a deceased employee. If the association pays employees in arrears, any remaining salary or other compensation due becomes an asset of the estate. Similarly, if state law or association policy requires payment of accrued, unused paid time off (PTO) or vacation when employment ends, the amount of accrued PTO also becomes an asset of the estate.

Associations should either wait to make these final salary and accrued PTO payments until a court has appointed a personal representative of the employee’s estate, or consult counsel about whether it is legally permitted to make these payments before receiving notice of the court appointment. Upon receiving proof of the court-appointed representative, the association may make these payments to the estate at the representative’s direction. He or she will then handle the distribution of assets from the estate.

If the association pays these amounts to another party before a personal representative is appointed (such as directly to a surviving spouse), or without the representative’s authorization and not otherwise in compliance with applicable legal requirements, the estate or beneficiaries could bring a claim for the improper distribution of these assets.

Many states have a small-asset exception that may allow the association to pay these final amounts if a personal representative is not appointed in a timely manner. State laws vary, so it is important to confirm whether such an exception applies. The state law where the deceased employee was a legal resident will generally govern this issue, even if the employee worked in an association’s office in another state.

Tax Withholding and Reporting

Any compensation paid to a deceased employee’s estate or beneficiaries during the calendar year of death will be subject to employment tax withholding (Social Security, Medicare, and federal unemployment tax withholding) but not income tax withholding. Any amounts paid after that year are not subject to any tax withholding. State income tax withholding is often not required, regardless of when the compensation is distributed. The association should confirm applicable state law.

Any compensation paid to a deceased employee’s estate or beneficiaries during the calendar year of death will be subject to employment tax withholding but not income tax withholding.

Amounts paid to the estate or beneficiaries during the year of death that are subject to employment tax withholding should be reported on an IRS Form W-2 issued to the deceased employee in January of the year after the year of death as Social Security and Medicare wages only. Amounts paid to a deceased employee’s estate or beneficiaries during any year following the year of death are not reported on a Form W-2.

The association must also issue to the estate or beneficiaries receiving any distributions a Form 1099-MISC reporting the distribution as taxable income during the year in which the amount is distributed. A Form W-9 will need to be collected from each party receiving a distribution to obtain the party’s full legal name, address, and taxpayer identification number.

Other Benefits and Executive Compensation Arrangements

Group health plan benefits, qualified retirement plans, and other welfare benefits. The association should follow the same processes for terminating health, dental, vision, and other welfare benefits as it follows for other employees who terminate employment. Insurers and plan administrators should be notified of the death. Coverage for any dependents participating in the plans will cease in the same manner as other terminations of employment (typically on the last day of employment or the last day of the month in which death occurs, depending on the terms of the benefit plans), and the association should follow its standard procedures for notifying the dependents of eligibility for COBRA coverage.

The association should notify the administrator of any qualified retirement plans that the employee has died. Distribution of the employee’s retirement account balance would be made to the beneficiaries or the estate, depending on the terms of the plan. Life insurance benefits would be paid by the carrier directly to any designated beneficiaries in accordance with policy terms.

Supplemental executive retirement benefits and deferred compensation plans. If the association maintains a supplemental executive retirement plan (SERP) or any other nonqualified deferred compensation plans, accrued benefits should be paid in accordance with the terms of the plan documents. If the deceased employee designated a beneficiary, payment should be made directly to the beneficiary. The association should review a written, signed beneficiary designation form prior to distribution. If a beneficiary has not been designated, the association should follow the estate representative’s direction.

If the association fails to timely pay accrued benefits in accordance with plan terms, the benefit may become subject to adverse tax consequences, including an additional 20 percent income tax. The same tax withholding and reporting rules that apply to the payment of final salary and accrued PTO will apply to the payment of the accrued benefits.

Coworkers may also experience grief when a fellow employee dies. The association should remind employees of any Employee Assistance Program or other resources available to them

Other Considerations

The association will need to manage a few additional issues as well:

  • If the deceased employee worked remotely, the association should make arrangements for return of its property and any documents containing confidential information—while being careful to make such requests of grieving family members at an appropriate time.
  • Coworkers may also experience grief when a fellow employee dies. The association should remind employees of any Employee Assistance Program or other resources available to them and consider offering paid time off for employees to attend their coworker’s funeral.
  • While there are legal restrictions on employers paying a deceased employee’s wages, there is no legal impediment to voluntarily providing assistance with funeral arrangements—provided that the amounts are small enough to not constitute “impermissible private benefit” if the association is exempt from federal income tax under Section 501(c)(3).

In addition to the emotional toll on coworkers, the death of an employee could have a significant impact on an association’s ability to continue its ordinary course of business. While it may be desirable to resolve any outstanding compensation issues as quickly as possible, the association should seek advice from a qualified tax professional to avoid potentially subjecting the organization to additional liability to the deceased employee’s estate and beneficiaries.

Keith Ranta

Keith Ranta is a partner at Pillsbury Winthrop Shaw Pittman LLP in Washington, DC.

Julia E. Judish

Julia E. Judish is special counsel at Pillsbury Winthrop Shaw Pittman, LLP, in Washington, DC.