Employees who lose wages as a result of illness or a nonwork-related accident are eligible to receive disability payments, also known as third-party sick pay. This coverage is typically part of an employee’s benefits package as a way for employees who get sick, injured, or are temporarily disabled to receive compensation while out of work.
Payments are similar to an employee’s regular paycheck, except they only get a percentage of their normal gross pay. Another difference is that these checks are issued by the insurance company or third-party provider. Both the employee and employer are required to keep a record of the payments received while the worker is away from the job. Even though payments are dispersed by a third-party, employers are responsible for Social Security and Medicare withholdings, Federal Unemployment Tax (FUTA), and State Unemployment Tax (SUTA). Note that regulations can vary between regions.
Third-party sick pay is considered earned income if the individual receives it within six months after leaving work from an incident. This is due to the fact that sick payments are made in place of regular wages. If sick leave is received more than six months after work is discontinued, it’s classified as unearned income.
Yes, third-party sick pay is taxable unless the insurance premiums are paid with after-tax dollars. Depending on the coverage plan, premium costs might be covered by the employer, employee, or both parties. Regardless of who is paying the premiums, sick pay is taxable when these premiums are paid with pre-tax dollars.
Although sick payments are typically made with pre-tax dollars, some plans make payments with after-tax dollars. If this is the case, sick pay becomes non-taxable. Sick pay is also nontaxable if death occurs during the period in which the employee is receiving third-party sick pay. Payments issued after death to an estate or survivor are not eligible to be taxed.
It’s important to note that sick pay must be reported on the employee’s W-2 regardless of tax implications. Employees are required to document the following information:
Here’s an example from the IRS explaining how an employee might report sick pay if they received payments during 2017:
|Dave, an employee of Edgewood Corporation, was seriously injured in a car accident on January 1, 2017. Dave’s last day of work was December 31, 2016. The accident wasn’t job-related.
Key, an insurance company that wasn’t an agent of the employer, paid Dave $2,000 sick pay each month for 10 months, beginning in January 2017. Dave submitted a Form W-4S to Key, requesting $210 be withheld from each payment for federal income tax. Dave received no payments from Edgewood, his employer, from January 2017 through October 2017. Dave returned to work on November 1, 2017.
For the policy year in which the car accident occurred, Dave paid a part of the premiums for his coverage, and Edgewood paid the remaining part. The plan was, therefore, a “contributory plan.” During the 3 policy years before the calendar year of the accident, Edgewood paid 70% of the total of the net premiums for its employees’ insurance coverage, and its employees paid 30%.