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Preparing Payroll for Year-End: Third Party Sick Pay


Each year, employers across the country realize that they need to adjust their payroll data after their final payroll run of the year.  In a special three-part blog series, we explore the three most common adjustments that can be avoided with just a little planning. In this, the third issue of this three-part series, we explain third-party sick pay and the associated complexities of tax payments and reporting.

When a third party, usually an insurance company, issues sick pay to an employee, it isn’t always clear who is responsible for taxes and tax reporting.  Based on the plan contract, the responsibility for remitting payroll taxes withheld to federal, state and local jurisdictions can fall to either the third-party administrator or the employer.  The employer, generally, still must remit matching shares for Social Security and Medicare tax and report for state and federal unemployment taxes even if the third-party remits the withheld taxes.  It is important to understand that regardless of which party is responsible for remitting the taxes, the responsibility for issuing a Form W-2 to the employee for sick pay may again fall to either party. The key to understanding who carries these responsibilities depends on the terms of the plan contract.

BenefitMall encourages clients to work with their dedicated Payroll Specialist to determine who manages the tax payment and W-2 reporting requirements for third-party sick payments. The best way for your Payroll Specialist to be able to assist you is for you to provide BenefitMall with a copy of your plan contract. Although most of the information needed should be included in the contract, some will change on a claim-by-claim basis and additional information may be required from time to time.

The information requested by your Payroll Specialist may include:

  • What is the name of your third-party administrator? This is most likely the insurance company that handles your disability insurance plan. This information may need to be reported to the IRS in case of additional information requested by that agency.
  • What type of sick pay was issued to the employee?  There are separate earnings codes that need to be reported for different types of third-party sick pay (e.g. short-term vs. long-term disability).
  • Who provides W-2 to employee? If BenefitMall prepares your W-2s, it is important that we understand whether you or your third-party administrator are issuing the W-2s to employees for sick pay. Either not reporting the sick pay at all or double reporting (both you and the third-party administrator issue W-2s) becomes an issue.  Discrepancies are likely to be apparent when the IRS compares W-2s and Form 941, exposing your business to the possibility of an audit, penalties or fines.
  • Does the employee contribute to the cost of the plan? Because the taxability of the benefit paid out is the same as the cost, whether or not the employee contributed to the plan premiums will affect the taxability. For example, if the employer pays 100% of the premiums for the plan, the benefit paid to the employee is 100% taxable. On the other hand, if the employee pays 50% of the plan premiums, only 50% of the benefit paid is taxable.  Both taxable and nontaxable portions are reported on the employee’s W-2, so it is important that your Payroll Specialist knows the details of the employee’s contribution to the plan.
  • What percentage of the employee’s contribution to plan cost is on an after-tax basis? How the employee’s premium payment was calculated during payroll (pretax vs. after-tax) affects taxation as well as how and where it is reported on the employee’s W-2.
  • What was the last day the employee worked? Taxable third-party sick earnings are fully taxable for up to six months after the last day the employee worked. After six months, third-party sick income is only taxable for federal income tax withholding (FITW) and state withholding tax (SWT).
  • Has all third-party sick information been entered into payroll?  Employers should report third-party sick earnings as soon as they are provided to the employee even if the W-2 is issued by a third-party administrator. By doing so it ensures that the employer share of payroll taxes for the third-party sick pay are calculated correctly and on time. Special earnings codes may apply, so it is best to work closely with your Payroll Specialist to ensure proper recording of sick pay in payroll records.

If your company uses a third-party administrator to manage your sick pay, we encourage you to work closely with your dedicated Payroll Specialist to ensure appropriate tax payments and reporting. Not a BenefitMall client?  We can help!  Contact us today to find out how we can help you make sense of third-party sick pay.

Don’t miss the previous posts in this special year-end series. How W-2 information verification can help to make your payroll year-end process easy and painless and advice on managing year-end bonuses are both available for viewing in our BenefitMall Business Blog. Be sure to subscribe to the blog through our RSS subscription feature too!

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