Reporting Non-Taxable Sick Pay on Your W-2

Sick pay provides compensation to employees who are unable to work due to illness or injury. This income is generally taxable, just like regular wages. However, under specific circumstances defined by tax regulations, a portion or all of these payments can be considered non-taxable. The taxability often depends on who funded the plan that provides the benefits.

Conditions for Non-Taxable Sick Pay

The tax treatment of sick pay, including short-term and long-term disability benefits, hinges on how the insurance plan is funded. If you, the employee, pay the premiums for a disability insurance policy using your own after-tax dollars, any benefits you receive from that policy are not subject to federal income tax.

Conversely, if your employer pays the premiums for the sick pay plan, the benefits you receive are taxable. If the plan is funded with pre-tax dollars, such as through a cafeteria plan where you contribute by reducing your salary before taxes are calculated, the benefits are also taxable. In situations where both you and your employer contribute to the plan, the taxability of the benefits is proportional. For instance, if you paid 40% of the premiums with after-tax money and your employer paid 60%, then 40% of the benefits you receive would be non-taxable.

Reporting Non-Taxable Sick Pay on Form W-2

When you receive non-taxable sick pay, it is reported for informational purposes on your Form W-2. The amount of non-taxable sick pay paid by a third party, like an insurance company, will appear in Box 12 with the designation “Code J”. Box 13 will also be checked to indicate you received third-party sick pay. This amount is not included in your taxable wages, which are reported in Box 1 of the W-2.

Even if sick pay benefits are exempt from income tax, they are often still subject to Social Security and Medicare taxes, collectively known as FICA taxes. These taxes apply to sick pay for the first six calendar months after the last month you worked. If FICA taxes were withheld, the wages subject to these taxes will be included in Box 3 and Box 5. The corresponding taxes withheld will be shown in Box 4 and Box 6. After the six-month period, the payments are exempt from FICA taxes.

Third-Party Sick Pay Considerations

It is common for sick pay and disability benefits to be paid by a third party, such as an insurance company, rather than directly by your employer. This third-party payer has specific tax reporting responsibilities. The responsibility for withholding and reporting can be determined by an agreement between your employer and the third party. Depending on this agreement, you might receive a Form W-2 directly from the insurance company that paid your benefits.

This W-2 from the third party will detail the sick pay you received and any taxes that were withheld. Federal income tax is not withheld from third-party sick pay unless you specifically request it by submitting Form W-4S, Request for Federal Income Tax Withholding From Sick Pay, to the payer. If the employer retains responsibility for reporting, they will receive a statement from the third party by January 15 of the following year and include the sick pay information on the W-2 they issue to you.