- Oregon Payroll Tax and Registration Guide - December 16, 2021
- Utah Payroll Tax and Registration Guide - December 4, 2021
- Texas Payroll Tax and Registration Guide - December 4, 2021
When they are absent from work, employees should receive the full or a percentage of their gross wage. The federal authorities in the United States don’t impose a mandatory paid sick leave on employers, although currently, 16 states do require businesses to offer sick pay to their employees.
An employer has to report the income an employee receives while they’re away from work to the federal tax authorities, along with their annual income.
However, funds received during sick leave are taxable only under certain conditions, so in this article, I’m going to help you find out what third-party sick pay is and show you how and when to apply federal payroll taxes to it.
What is Third Party Sick Pay?
Sick leave or sick pay is the time off employees receive while they are away from work due to injury, temporary disability, or illness. Employees are eligible for sick leave even if an injury that caused them to miss time at work didn’t occur at a workplace.
An employee must meet the following requirements to receive sick pay:
- Treatment of physical or mental illness
- Preventive medical care
- Lingering health condition, temporary illness, or injury
- Providing care for an ill or injured family member
- Medical diagnosis
Depending on the type of work contract they have, employees are entitled to full or partial pay during the time they’re unable to work. Currently, there is no federal legislation that makes paid sick leave mandatory, but some states such as Oregon or Nevada impose paid sick leave on all employers.
Those businesses that do offer sick leave plans to their employees often choose to do so through third-party administrators.
In some cases, employers can choose to handle sick leave payments internally and bypass the insurance companies. Doing so makes a business responsible for covering both short and long-term sick pay.
Organizations that choose to process sick pay internally assume the insurance risk and deposit all funds directly to the employee.
Differences Between Earned Income and Third-party Sick Pay
The purpose of sick pay is to replace an employee’s regular wages during the time they’re unable to work. All sick leave payments are regarded as earned income if received within six months after an employee had to stop working.
Consequently, employees are required to withhold federal payroll taxes from the employee’s third-party sick pay, but only if an employee spends less than six months away from work.
Sick leave payments received after more than six months of work discontinuation are regarded as unearned income, and as such, they’re not subject to payroll taxes.
Depending on the employer’s coverage plan, employees can receive both short-term and long-term sick pay from third parties. It is worth pointing out that the federal tax authorities may treat sick pay as supplemental wages if the third party acts as an employer’s agent.
Who Can Pay Third-party Sick Pay?
Businesses that opt to handle sick pay through an insurance company can choose if they want the third party to act as their agent or not.
In either case, the third party is responsible for making payments to an employee, and a business that has this type of insurance doesn’t have to pay wages to their workers during a sick leave period.
In case a third-party acts as the business’ agent, the business is responsible for withholding federal payroll taxes sick leave payments. Third-party administrators that don’t have the status of employer’s agent have to use their EIN to process federal payroll tax withholdings.
How to Set Up a Third-party Sick Pay Plan?
An employer must produce a written plan that contains an employee’s requirements to receive third-party sick pay. Once the businesses and third parties agree to the plan terms, the business must start making contributions to the third party and covering their monthly fees.
An employer must submit the following information to the third party if an employee is forced to spend time away from work:
- Employee’s gross annual wage
- The after-tax amount the employee contributed to the sick pay plan
- Employee’s name and social security number
- The employee’s last workday
The insurance company then uses this information to allocate the correct sum to the employee’s account instead of their regular wage.
Taxable Third-party Sick Pay
The sick pay an employee receives during their time off is subject to federal payroll taxes. These taxes can be covered by the third-party, employer, employee, or shared between the employer and the employee.
Although third parties that don’t have the status of the business’ agent are responsible for withholding federal payroll taxes, they can request to transfer this responsibility to the employer. Also, third-party sick pay is only taxable under the following conditions:
- If the employer and the employee share the costs of premium insurance and the costs are covered with pre-tax dollars.
- If the employee pays the entire premium with pre-tax dollars, the sick pay is taxable to the employee.
- If the employer pays the insurance premium
All taxes withheld from the employee’s sick pay have to be paid and submitted to the IRS.
Non-taxable Third-party Sick Pay
Federal payroll taxes don’t apply on third-party sick pay if the premium is paid with after-tax dollars. In addition, sick pay isn’t taxable if the employee dies during the time they’re unable to work, as well as the payments issued to the employee’s beneficiaries.
Third parties, employers, and employees must reach an agreement to make sick pay plan contributions from after-tax dollars if they want to avoid the costs of federal payroll taxes.
Filing Third-party Sick Pay
Federal payroll taxes include federal income, social security, Medicare, and unemployment insurance taxes.
All employees on the territory of the United States are required to complete the W-4 form when starting a new job. This form contains information regarding their preferred filing method, number of dependents, and additional sources of income.
An employer should use the data provided in the form to calculate the federal payroll tax withholdings for an employee’s sick pay. These taxes should be paid as frequently as payroll taxes for regular wages, so employers can choose to submit them semiweekly or monthly.
Both the employer and the third party have to fill out and submit several documents to the IRS along with tax withholdings.
- Form 940 – This form is used to file for FUTA tax, and an employer has to complete it and submit it together with other documentation required to file taxes for third-party sick pay.
- Forms 941 and 944 – Third-party and employers must use the 941 and 944 forms while filing for federal quarterly and annual tax returns.
- Form 8922 – The third-party sick pay can be filed by a third party or the employer depending on whose EIN is included on the W2 form. An employer must submit this document if the name and EIN of the third party are on the W2 form. The third-party is responsible for filling this form if the employer’s name and EIN are included in the W2 form.
- W2 form – The wage and tax statement form can be submitted to the IRS by the employer or the third party.
The W2 form must include the following information:
- The sick pay amount paid by the third party that is not included in the income
- Total sick pay amount paid to the employee
- Withheld federal income taxes
- Withheld FICA taxes
Also, employers must match the federal social security and Medicare taxes as they normally would for an employee’s wage and cover the entire cost of the FUTA tax.
Frequently Asked Questions about Third Party Sick Pay
Answer: You can continue receiving the third-party sick pay for as long as your employment status remains unchanged.
Answer: An employer or a third party must make sure that box 13 in the W-2 form is checked while filing payroll taxes withheld from an employee’s sick pay. Checking this box indicates that the employee received payments during the sick leave.
Answer: Yes, employers can use third-party sick pay plans provided by several different third-party agents and insurers.
Answer: Paid Time Off policies usually bundle several types of leave, as they include vacations, leave for personal reasons, or sick leave, while the third party sick leave can only be used if an employee is ill or injured.
Final Thoughts
Employers and employees must pay federal payroll taxes for third-party sick pay if the insurance premium contributions are made from pre-tax dollars. The sick pay isn’t taxable if it is funded from after-tax dollars, but this is rarely the case.
Hence, most employers and employees have to withhold federal payroll taxes for all third-party sick payments. The process of filing taxes for sick leave payments made by third parties can be difficult because it involves filling out several forms.
Was this article useful? Let me know in the comments.