What Is 3rd Party Sick Pay & How Is It Reported?
Understand how payments from external entities for employee illness are handled for tax and compliance purposes.
Third-party sick pay refers to payments an employee receives from an entity other than their direct employer when unable to work due to illness or injury. This arrangement typically involves an insurance company, trust, or state disability fund providing wage replacement benefits. These payments ensure an employee continues to receive income during an approved absence, even if their regular employer does not directly issue the funds.
Understanding Third-Party Sick Pay
Third-party sick pay encompasses various wage replacement benefits, such as short-term or long-term disability benefits. These payments originate from a third party, like an insurance carrier or a state disability insurance program. They are also common when an employer’s self-insured plan is administered by an external entity. This type of compensation substitutes an employee’s regular wages during temporary absence from work due to a non-job-related sickness or injury.
These payments replace a portion of the employee’s lost income during disability leave. For instance, if an employee is on extended medical leave, their employer’s disability insurance provider might issue weekly or bi-weekly payments directly to the employee. These benefits are for periods of temporary disability and do not include payments for medical expenses or permanent disability retirement.
Tax Implications of Third-Party Sick Pay
Third-party sick pay is generally considered taxable income for the employee, much like regular wages. It is typically subject to federal income tax withholding (FIT) and may also be subject to Social Security and Medicare taxes (FICA). The taxability of these benefits depends on who paid the insurance premiums. If the employee paid premiums with after-tax dollars, the sick pay is non-taxable. If the employer paid premiums, or if the employee paid them with pre-tax dollars (e.g., through a cafeteria plan), the benefits are taxable.
For employers, FICA tax responsibility on third-party sick pay varies based on the arrangement with the third-party payer. In one common scenario, the third-party payer withholds and deposits the employee’s share of FICA taxes and also pays the employer’s share directly to the Internal Revenue Service (IRS). Alternatively, the third-party payer might transfer the liability for the employer’s share of FICA taxes to the employer. The third party provides the employer with the necessary information, and the employer becomes responsible for reporting and paying their portion of the FICA taxes.
Employer Reporting Requirements
Accurate reporting of third-party sick pay requires close coordination between the employer and the third-party payer. The primary document for reporting these payments to employees is Form W-2. Taxable third-party sick pay is included in Box 1, “Wages, tips, other compensation,” of the employee’s Form W-2. If any portion is non-taxable because the employee contributed with after-tax dollars, it is reported in Box 12 with Code J.
Employers also report their share of FICA taxes on third-party sick pay on Form 941, Employer’s Quarterly Federal Tax Return. Form 8922, Third-Party Sick Pay Recap, reconciles employment tax returns with Forms W-2 when third-party sick pay is involved, especially when FICA tax liability is split. The third-party payer provides the employer with a statement by January 15th of the following year, detailing sick pay amounts and any taxes withheld, which is crucial for the employer to complete their reporting obligations.