Third-party sick pay is income paid to an employee who is unable to work due to illness, injury, or disability, where the payment comes from someone other than the employer. That third party is typically an insurance company or a trust fund.
It functions like a wage replacement benefit. The employee keeps receiving income while out, but the money flows through an outside payer.
Who pays third-party sick pay?
The payer is usually an insurer the employer has contracted with to provide short-term or long-term disability coverage. Some employers use self-funded trusts or state-mandated programs instead.
Regardless of who funds it, the employer is still responsible for certain tax and reporting obligations tied to those payments.
Is third-party sick pay taxable?
It depends on who paid the insurance premiums. The tax treatment follows a straightforward rule:
Who paid the premium? | Is the sick pay taxable? |
Employer paid 100% | Yes, fully taxable to the employee |
Employee paid with pre-tax dollars | Yes, fully taxable to the employee |
Employee paid with after-tax dollars | No, not taxable to the employee |
Split between employer and employee | Taxable on the employer-funded portion only |
Most employer-sponsored disability plans are employer-paid, which means the sick pay is typically taxable.
How is third-party sick pay reported on a W-2?
The third-party payer usually issues a W-2 to the employee directly, or the employer includes the payments on the employee's regular W-2. The handling depends on whether the insurer has assumed full responsibility for withholding and depositing taxes.
If the third party withholds and deposits all applicable taxes, it issues its own W-2. If the employer retains that responsibility, the amounts appear on the employer-issued W-2.
What are the employer's payroll tax responsibilities?
Even when a third party handles the payments, employers may still owe their share of FICA taxes on the sick pay. The specific obligations depend on whether the insurer is acting as the employer's agent.
Key employer responsibilities often include:
Depositing the employer portion of Social Security and Medicare taxes
Reporting the payments on Form 941
Ensuring sick pay is included in the employee's W-2
Filing Form 8922 if the third party reported FICA taxes separately
What is Form 8922 and when is it used?
Form 8922 is an IRS form used to reconcile third-party sick pay when the third party and the employer split the responsibility for withholding and reporting. It makes sure the totals on Form 941 and the W-2s line up correctly.
Not every employer needs it. It is only required when the insurer withholds and deposits the employee's FICA taxes but the employer reports the wages.
Key Takeaways
Description | |
Definition | Wage replacement payments made by a third party, typically an insurer, when an employee cannot work |
Taxability | Depends on who paid the premium; employer-paid premiums make the benefit fully taxable |
W-2 reporting | Either the third party or the employer issues the W-2, depending on who handles tax withholding |
Employer obligations | May include depositing FICA taxes and reporting payments on Form 941 |
Form 8922 | Used to reconcile sick pay taxes when responsibilities are split between the insurer and employer |
Frequently Asked Questions
Does third-party sick pay count toward Social Security benefits?
Yes, as long as it is paid within six months of the employee's last day of work. After that point, it is generally not subject to Social Security tax.
Does the employee need to do anything to receive third-party sick pay?
Typically yes. The employee files a disability claim with the insurer and may need to provide medical documentation. The employer often needs to confirm the absence as well.
Is third-party sick pay the same as workers' compensation?
No. Workers' compensation covers job-related injuries and is generally not taxable. Third-party sick pay covers non-work-related illness or disability and may be taxable depending on how premiums were paid.
How long can an employee receive third-party sick pay?
That depends on the policy. Short-term disability plans typically cover a few weeks to six months. Long-term disability plans can extend for years or until retirement age.
