Wages earned by employee but not paid-require W2?

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.

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.

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.

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

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.

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.

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.

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.