Third-party sick pay is a disability or illness payment made to an employee by someone other than the employer — typically an insurance company under a group policy — and it carries its own rules for FICA, federal income tax withholding, W-2 reporting, and reconciliation with the IRS. The tax treatment turns on two questions: who is paying (an agent of the employer or an independent insurer), and how the premiums were funded. Get those two right and the rest of the reporting falls into place.
What Counts as Sick Pay
Sick pay under these rules is any amount paid to an employee under an employer-sponsored plan while the employee is temporarily absent from work because of sickness or personal injury, and paid by a third party rather than out of the employer’s own payroll. Short-term and long-term disability benefits under a group insurance policy are the standard example. Payments from a multi-employer welfare fund or a state-sponsored disability plan can also qualify.
Some things that look like sick pay aren’t. Disability retirement payments, reimbursements for medical or hospitalization expenses, and workers’ compensation benefits fall outside the definition, even when paid by a third party under the same group policy. The word doing the work is “temporarily.”
Agent or Non-Agent: Who Owes the Tax
The most consequential distinction is whether the third party is acting as the employer’s agent or as an independent insurer, because that decides who is on the hook for employment taxes.
An agent bears no insurance risk and is reimbursed on a cost-plus-fee basis for paying benefits. A third-party administrator that processes claims and cuts checks using the employer’s money is an agent, even if it decides which employees qualify. An agent generally has no independent responsibility for employment taxes; the obligation stays with the employer unless the two sides sign an agreement shifting those duties.
A non-agent bears the insurance risk itself. An insurance company collecting premiums under a group disability policy is the standard case. A non-agent payer has direct liability for the employee’s share of Social Security and Medicare taxes, and for the employer’s share as well unless it takes specific steps to transfer that liability back.
How Much of the Benefit Is Taxable
The portion of sick pay attributable to premium contributions the employee made with after-tax dollars is excluded from both income and employment taxes. If the employee paid the entire premium with after-tax money, none of the benefits are taxable. If the employer paid the full premium, all of it is taxable. Most plans split the cost.
There is a trap in how the employee’s share is paid. When employees contribute through a cafeteria plan using pre-tax salary reductions, the IRS treats those contributions as employer-paid, and the full benefit becomes taxable. Only dollars that were already taxed reduce the taxable portion. The agreement between the employer and the insurer should state the excludable percentage.
FICA, FUTA, and the Six-Month Rule
Sick pay is subject to Social Security and Medicare taxes during the first six calendar months after the employee last worked. The clock starts with the last calendar month the employee was on the job. If the employee last worked in March, sick pay is subject to FICA through September and becomes exempt starting in October.
The same six-month cutoff applies to Federal Unemployment Tax. After six calendar months following the last month worked, sick pay is no longer “wages” for FUTA either.
During the taxable window, the standard FICA rates apply: 6.2% for Social Security and 1.45% for Medicare on the employee side, with a matching amount owed by the employer or liable third party. Additional Medicare Tax of 0.9% applies once the employee’s total wages for the year exceed $200,000.
Federal Income Tax Withholding Is Voluntary
Federal income tax withholding on third-party sick pay is not automatic. A third-party payer has no obligation to withhold income tax unless the employee submits Form W-4S to the payer.
On Form W-4S, the employee specifies a flat dollar amount to withhold from each payment. The request takes effect for payments made more than seven days after the form is submitted, and the employee can change or cancel it at any time by submitting a new written statement.
Transferring the Employer’s Share Back to the Employer
A non-agent insurer starts out liable for both the employee’s and employer’s shares of FICA plus FUTA. To move the employer’s share back to the employer, the third party must do all three of the following:
- Withhold the employee’s portion of Social Security and Medicare taxes from each sick pay payment.
- Deposit those withheld employee taxes with the IRS on the third party’s normal deposit schedule.
- Notify the employer of the payments on which taxes were withheld and deposited, within the time required for the third party’s own deposit of the employee taxes.
Complete all three, and the employer becomes responsible for the employer’s share of FICA and for FUTA on those payments. Miss any one, and the third party stays liable. Late or incomplete notifications from an insurer are a common source of surprise assessments, because neither side realizes the liability never transferred until the IRS says so.
W-2 Reporting
Sick pay must appear on Form W-2 even if the entire benefit is nontaxable. Who issues the W-2 depends on where the tax liability ended up. If the third party kept the liability (didn’t complete the transfer steps), the third party issues the W-2 under its own name and EIN. If the liability transferred to the employer, the employer issues the W-2 under its own name and EIN, either combining the sick pay with regular wages on one W-2 or issuing a separate one.
The boxes that carry third-party sick pay:
- Box 1, Wages, tips, other compensation: the taxable portion of sick pay the employee must include in income.
- Box 3, Social Security wages: the amount subject to Social Security tax, which exists only during the first six months.
- Box 5, Medicare wages and tips: the amount subject to Medicare tax, again limited to the first six months.
- Box 12, Code J: any sick pay that was nontaxable because the employee contributed to the plan with after-tax dollars. This amount is excluded from Boxes 1, 3, and 5.
- Box 13: the “Third-party sick pay” checkbox must be checked.
Code J captures only the nontaxable portion. If the employer paid the entire premium, Code J is zero and the full benefit sits in Boxes 1, 3, and 5, subject to the six-month rule for Boxes 3 and 5.
Form 941 Line 8 Adjustment
Employers reconcile sick pay on their quarterly Form 941. Line 8 is designated for the current quarter’s sick pay adjustment. When the employer receives notification that a third-party payer issued sick pay to employees, line 8 captures the difference between the taxes reported on the employer’s return and the taxes the third party already withheld and deposited. Without it, the same wages can end up taxed twice or not at all.
Form 8922 Reconciliation
Because reporting duties are split between two parties, the IRS requires a reconciliation on Form 8922, Third-Party Sick Pay Recap. Form 8922 is filed directly with the IRS and replaced the older practice of filing special sick pay recap versions of Forms W-2 and W-3 with the Social Security Administration.
Which party files Form 8922 depends on whose name is on the employee’s W-2. If the W-2 was issued under the insurer’s name and EIN, the employer files Form 8922. If the W-2 was issued under the employer’s name and EIN, the insurer files it. The party whose employment tax return doesn’t match the W-2 amounts is the one that files the recap.
Form 8922 is due by the last day of February following the year the sick pay was paid, with the deadline moving to the next business day if that date lands on a weekend or holiday. An employer that works with multiple insurers files a separate Form 8922 for each.
Deadlines and Electronic Filing
Form W-2 must be furnished to employees and filed with the Social Security Administration by January 31 following the year of payment, through the SSA’s Business Services Online portal for electronic submissions. If January 31 falls on a weekend or holiday, the deadline shifts to the next business day.
Employers filing 10 or more information returns of any type in a calendar year must file electronically. That threshold is aggregate across nearly all information return types, so six W-2s and four 1099s together hit the 10-return mark and trigger the e-file requirement for everything. Paper filing remains available only for employers below the threshold.
Form 941 follows its normal quarterly schedule, with the sick pay adjustment on line 8 of the quarter in which payments occurred.
Recordkeeping
Employment tax records, including all documentation of third-party sick pay, must be kept for at least four years after the tax becomes due or is paid, whichever is later. That covers every W-2 issued, every Form 8922 filed, every notification received from the insurer, and every Form 941 adjustment tied to sick pay.