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Wages earned by employee but not paid-require W2?

An employee earned wages that the company could not pay during the year. To evidence the liability, the company issued a note payable to the employee. The employee sold the note to a third party that agreed with the company to convert into equity. The question is whether the company is obligated to issue a W-2 to the employee or third party.

Answers

Anonymous
(Controller) |

Generally wages are taxable. The evidence of a negotiable notes payable indicates that the note has economic value. You likely are going to claim a tax deduction for the wages so the IRS will claim in substance an exchange has occurred. I do suggest you consult with a tax specialist on this transaction.

Ted Monohon
Title: VP -Finance / Controller
Company: Fantex
(VP -Finance / Controller, Fantex) |

There could be some state level DOL issues with not paying an employee wages due by a certain time, so you will want to be careful about reporting this on a W-2. Did you withhold and submit the FICA, Medicare, state and federal taxes to the appropriate agencies? Lots of legal and tax issues that creep up around this. You will want to consult legal counsel on this.

Topic Expert
Karoline Mello
Title: Director, FP&A
Company: Apollo Group
(Director, FP&A, Apollo Group) |

There are multiple regulatory issues here – do you have a tax attorney? I would verify, but I suspect the IRS would require you to report the income on a W-2 because the employee is required to report it to the IRS. I would treat it as wages and also report and pay the SS/Fico and all associated costs.

Lorenzo Morales
Title: Administrative Liaison
Company: Ajo Ambulance, Inc
(Administrative Liaison, Ajo Ambulance, Inc) |

If it looks like duck, walks like a duck, quacks like a duck...

Topic Expert
Wayne Spivak
Title: President & CFO
Company: SBAConsulting.com
LinkedIn Profile
(President & CFO, SBAConsulting.com) |

I would just add, from the employee side, we are on the cash basis (some people are exceptions to this rule). So, until the wages are paid, we owe "no tax". However, that will involve a whole bunch of documentation being sent to the IRS/State to verify the veracity that payment was not made.

I agree with the overall sentient - Speak with a good tax attorney.

Topic Expert
Paul Benedetto
Title: CFO, Director of Finance, Consultant
Company: Nextwave Software, Rethink Fabrics
(CFO, Director of Finance, Consultant, Nextwave Software, Rethink Fabrics) |

Yes, lots of interesting layered issues going on here; almost kind of reminds me of a CPA exam type question ;). I would suggest initially reviewing IRS section 409 rules on deferred compensation to see how it may apply to this situation and it certainly does make sense like others have suggested, to consult a tax expert for their views. However, based on the information provided in this query thus far, I would not issue a W-2 to the employee. W2’s normally reflect cash basis wages paid during a calendar year. As such, I would treat this initially much like payroll periods that do not align exactly with a particular period end - requiring a wage accrual, then reversal for GAAP reporting purposes.

I would more likely instead issue a 1099-MISC statement in this scenario, once cash payment was theoretically made. If the person that was to be paid is still an employee, I would might change my position somewhat, possibly reclassifying the unpaid wages as a deferred bonus…

Second, the promissory note in of itself should not trigger a tax statement (1098-MISC) until cash payments are made for interest.

The final element, the note being sold and then converted into company stock benefitting a third party surely complicates the accounting. In my view, this reality justifies reverting the original transaction of the COMPANY to something other than wages, possibly debiting professional fees or consulting expense, with the credit to equity.

However, on the original payee side (employee), she/he presumably by this point received a benefit of some sort (value) in selling the note to the third party. My assumption then is that ultimately the third party should be issuing a 1099-MISC to the employee, not the company, during the year that the economic benefit was received.

I am sure that government jurisdiction(s) would certainly argue differently, for their particular company and employee taxation elements according to the original transaction. However, in the end the company itself gained equity in lieu of a liability, of which was more than likely at a lesser amount than the original transaction. The final agreed to value of the equity I believe is going to drive the expense on the P&L.

Anthony Pascente
Title: CFO
Company: TWFG Financial Services
(CFO, TWFG Financial Services) |

I agree with Paul as this should be treated as a 1099-MISC income as from what I read it does not seem that you withheld any taxes etc from the promissory note that was given to the employee.

Edward Thill
Title: VP - Finance & Operations
Company: Performance Trust
(VP - Finance & Operations, Performance Trust) |

I'm not a tax attorney and you should definitely consult one but here are my thoughts:
- Issuing a 1099 is not appropriate since the liability is related to work performed by an employee. Whatever the timing of payments, this is a W-2 issue and employer taxes will have to be paid.
- Employees are typically cash basis tax payers so getting paid in a future period would generally simply show in that future W-2. However, the fact that the employee in this case received a negotiable instrument (or any other asset) in lieu of cash would seem to me to be the equivalent of payment for services and therefore taxable at that time.
- The conversion of the note to equity is an ownership transfer and has no immediate tax consequence.

Kevin Roones
Title: Senior Accounting Professional
Company: In-between
(Senior Accounting Professional, In-between) |

I agree. Since an employee is involved, a W-2 is the correct document to be issued. A 1099-MISC should only be issued to a non-employee or former employee for post-employment payments.

Rick Young
Title: President
Company: Private
(President, Private) |

Since the company gave him a note payable, it assumes that the employee is lending funds to the company an should issue a w-2 to him. Him selling the note is really of no payroll tax consequence. That's an investment between the new note holder and the company.

Anonymous
(Agent) |

I'm not sure you can un-payroll an employee to re-characterize wages, withholding amounts that are reported through the 941 filings sort of give them away in the year end reconciliation of W-2's, unless perhaps the employee is also an owner. If the company has no cash, it has big problems, need to get a tax attorney to obtain the correct advice and to try to help the owners deal with the payroll obligations under the tax code related to non payment of payroll taxes and employee withholding. These particular liabilities do not get extinguished, they wear black and white stripes or big orange jump suits.

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