Tax Updates – 24th August

When an employee dies: what employers, executors and families need to know about tax

The death of an employee is difficult enough for colleagues and family without the added complication of working out the tax treatment of any payments that follow. On 17 August 2026, Inland Revenue released Interpretation Statement IS 26/13, Income tax – payments by employers on the death of an employee to executors and family. It is the first comprehensive guidance of its kind and will be useful reading for employers, executors, and family members alike who are dealing with wages, holiday pay, discretionary bereavement payments, or other amounts owed at the time of an employee’s death.

Why this matters

Following a death, an employer may need to pay out accrued salary or wages, holiday pay, a retiring allowance, a contractual death benefit, a funeral contribution, or simply a compassionate one-off gift. Some of these payments are taxable to the recipient; others are not. Employers need to know whether PAYE, KiwiSaver, or student loan deductions apply, and whether the payment is deductible for income tax purposes. Getting the categorisation wrong can create unnecessary compliance costs, or an unexpected tax bill, for a grieving family.

Three categories of payment

IS 26/13 explains that a payment made by an employer to an executor of a deceased employee’s estate will generally fall into one of three categories, depending on why the payment was made:

• Employment income (section CE 1) – where the employment relationship is the substantial reason for the payment, such as accrued salary, holiday pay, or a discretionary payment made by reference to years of service.
• Pension income (section CF 1) – a gratuitous payment that would not have been made but for the employee’s services is treated as a pension, unless it is paid to the executor or family within 12 months of the death, in which case it is excluded and not taxable.
• Income under ordinary concepts (section CA 1(2)) – a catch-all that will rarely apply, but could capture periodic or recurring payments.

The key test for employment income is not whether the payment was made in return for services, and not simply whether the payment would not have arisen “but for” the employment. Instead, the Commissioner asks whether the employment relationship was the substantial reason for the payment. Payments made under an employment contract, or under a documented employer policy, will usually meet this threshold. By contrast, a genuinely voluntary compassionate payment made for reasons extraneous to the employment relationship — for example, out of sympathy for a young family — may not be employment income at all.

The 12-month rule for gratutious payments

One of the more practical points in the statement is the treatment of one-off, gratuitous payments. Where an employer makes a gratuitous payment to an executor or eligible family member within 12 months of the employee’s death, that payment is specifically excluded from the definition of a “pension” and will not be taxable under section CF 1 (though it may still be employment income if it is not truly gratuitous). Once that 12-month window has passed, a gratuitous payment motivated by the former employment relationship is likely to be taxable as pension income, and PAYE will need to be deducted.

The 28-day election for executors

Under section HC 8, where an executor receives an amount that would have been the deceased employee’s income had they still been alive, that amount is generally treated as income of the executor (and taxed at trustee rates, or the deceased’s marginal rates where the trustee concessions in subpart HC apply). However, if the amount is “reportable income” — such as salary or wages, or PIE income — and is received within 28 days of the employee’s death, the executor may instead elect to treat it as income derived by the deceased before their death. This election can avoid the need to obtain an IRD number and file a return for the estate, but executors should weigh up which approach produces the better overall tax outcome, given differing thresholds and social policy implications between the deceased’s personal return and an estate return.

Employer Obligations

For employers, the statement confirms:

• PAYE must be withheld from most payments made on an employee’s death, including salary, holiday pay, retiring allowances, contractual death benefits, and funeral allowances. Accrued holiday pay and other one-off amounts are generally treated as an “extra pay” rather than ordinary salary or wages, which affects how withholding is calculated.
• FBT is unlikely to arise, since compassionate assistance is not usually provided “in connection with” employment — though a fringe benefit could arise where an employer hosts a function for colleagues and family.
• KiwiSaver compulsory employer contributions are only required for salary and wages relating to periods up to the date of death.
• Student loan deductions cease from the date of death, as the outstanding loan balance is written off to nil under the Student Loan Scheme Act 2011.

On deductibility, the statement confirms that payments which are employment income will generally satisfy the nexus test in section DA 1 and be deductible. More interestingly, the Commissioner accepts that even a voluntary compassionate payment can be deductible where the employer can show a genuine business purpose — for example, protecting its reputation as a good employer — separate from the personal relationship between the parties. Employers bear the onus of establishing that nexus.

Payments to family members and third parties

The statement also deals with payments made directly to a family member or third party rather than the executor — for example, under section 65 of the Administration Act 1969, which allows an employer to pay amounts of up to $40,000 owing to a deceased employee directly to a spouse, partner, or person caring for the deceased’s children, without formal administration of the estate. Importantly, these amounts still legally belong to the estate, and the executor remains responsible for accounting for any income tax on them.

Practical takeaways

• Employers should review the substantial reason for any payment made on an employee’s death before assuming it is, or is not, taxable — contractual entitlements and documented policies point towards taxable employment income, while genuine, unprompted compassion points away from it.
• Gratuitous payments made within 12 months of death are generally the safest from a tax perspective for the recipient.
• Executors dealing with reportable income received within 28 days of death have a choice of treatment, and should consider the comparative tax outcomes before electing.
• Employers should stop student loan deductions immediately on notification of death, and confirm KiwiSaver contributions only extend to pre-death periods.

IS 26/13 runs to 37 pages and includes ten worked examples and two appendices covering executors’ return-filing obligations. We recommend employers with a bereavement policy, or executors currently administering an estate that includes employment-related payments, review the full statement or speak with us about how it applies to their circumstances.

This article is a general summary and does not constitute tax advice. Please contact us if you would like to discuss how IS 26/13 applies to your specific circumstances.