Is Third Party Sick Pay Taxable in NJ?
Unravel the complexities of New Jersey tax laws concerning sick pay paid by third parties. Get clarity on its taxable status, reporting, and employer responsibilities.
When individuals are unable to work due to illness or injury, they may receive payments to replace lost wages. The taxability of these payments can vary, particularly when they originate from a source other than an employer. A common question arises regarding whether such sick pay, when disbursed by a third party, is subject to income tax in New Jersey.
Understanding Third-Party Sick Pay
Third-party sick pay refers to income disbursed by an entity other than a direct employer to compensate an employee for wages lost due to a non-work-related illness or injury. These payments typically stem from insurance policies or trust funds. Common scenarios involve short-term or long-term disability benefits administered by an insurance carrier.
This arrangement differs from sick pay directly provided by an employer, where the employer remains the payer of record. In third-party sick pay situations, a separate organization assumes the responsibility for making these benefit payments.
New Jersey Taxation of Sick Pay
New Jersey gross income tax law generally considers sick pay as taxable income to the recipient. The tax treatment often depends on who paid the premiums for the sick pay plan. If an employer paid all or even part of the premiums for the plan, the benefits received are typically considered taxable income in New Jersey.
Conversely, if an employee paid 100% of the premiums for the sick pay plan using after-tax dollars, the benefits received are generally not taxable by the state. This principle aligns with the state’s broad definition of gross income under N.J.S.A. 54A:5-1.
Notably, Temporary Disability Benefits (TDB) received directly from the State of New Jersey are not subject to New Jersey state income tax. This exemption also extends to family leave insurance benefits.
Reporting Sick Pay for Tax Purposes
Recipients of third-party sick pay receive specific tax forms detailing these payments. The most common form is Form W-2, Wage and Tax Statement. Taxable third-party sick pay is typically included in Box 1, “Wages, tips, other compensation,” of the W-2.
However, if the sick pay is non-taxable, it may be reported in Box 12 of the W-2 with Code J. In some instances, particularly if the payments are not considered wages, the third-party payer might issue Form 1099-MISC, Miscellaneous Information, with the amount reported in Box 3, “Other income.” The responsibility for issuing these forms can fall to either the third-party payer or the employer, depending on their specific agreement.
When preparing a New Jersey income tax return, individuals should carefully review their W-2 forms, particularly Box 16, which shows state wages. For third-party sick pay that is not taxable in New Jersey, Box 16 may be blank or zero, even if Box 1 contains a federal taxable amount. If Box 16 is blank for a W-2 that primarily reports third-party sick pay, entering zero in that box is generally appropriate to prevent the federal wages from being treated as taxable in New Jersey.
Employer Obligations
Employers have specific responsibilities when their employees receive third-party sick pay. The third-party payer is generally responsible for withholding federal income tax from these payments if the employee submits Form W-4S, Request for Federal Income Tax Withholding From Sick Pay. Additionally, the third-party payer typically withholds employee FICA (Social Security and Medicare) taxes, although FICA taxes only apply to sick pay for the first six months of absence.
Employers remain responsible for their portion of FICA taxes on the taxable sick pay benefits. Depending on the arrangement with the third-party payer, the employer may also be responsible for collecting and remitting state income tax withholding. Employers must coordinate closely with third-party payers to ensure accurate reporting of wages and taxes on the employee’s Form W-2.
If an employer also provides supplemental sick pay in addition to the third-party benefits, they must handle the withholding and reporting for their direct payments separately. The IRS Publication 15-A, Employer’s Supplemental Tax Guide, provides additional guidance on these reporting requirements.