Third-party sick pay is income you receive from someone other than your employer’s payroll department — typically an insurance company, a multi-employer welfare plan, or a trust — when a non-work-related illness or injury keeps you off the job. Whether those payments are taxable, and how much tax gets withheld, turns almost entirely on one question: who paid the premiums for the disability policy behind the benefit.
Where the Payments Come From
The most common setup is a group disability policy your employer buys from a commercial insurance carrier. The carrier reviews your medical claim, decides whether you qualify under the policy terms, and pays you directly. Multi-employer plans work the same way for industries where workers move between participating companies, such as construction, entertainment, and hospitality; contributions from several employers pool together so coverage follows the worker. Trust arrangements hold assets set aside for disability benefits and pay from that pool.
Short-term disability generally runs 13 to 26 weeks. Long-term disability can continue for years, sometimes until retirement age. If your absence also qualifies under the Family and Medical Leave Act, disability payments can run alongside your FMLA leave.1U.S. Department of Labor. Fact Sheet 28P – Taking Leave from Work When You or Your Family Member Has a Serious Health Condition Under the FMLA FMLA protects your job for up to 12 weeks but doesn’t require your employer to pay you, so third-party sick pay fills the income gap while FMLA holds your position.
How Premiums Decide What’s Taxable
Three scenarios cover almost every situation.
- If your employer paid 100% of the premiums, the full sick pay amount is taxable. It’s subject to federal income tax withholding, Social Security, Medicare, and FUTA.2Internal Revenue Service. Publication 15-A (2026), Employer’s Supplemental Tax Guide
- If you paid 100% of the premiums with after-tax dollars, the payments are not taxable income at all. No income tax, no FICA, no FUTA.2Internal Revenue Service. Publication 15-A (2026), Employer’s Supplemental Tax Guide
- If premiums were split, only the portion tied to your employer’s share is taxable. The IRS looks at the employer’s percentage of the policy cost over the three policy years before the year the sick pay is received.
The split calculation is straightforward once you know the ratio. Say your employer paid 70% of the group policy premiums over the prior three years, and you paid 30% with after-tax dollars. Then 70% of each sick pay check is subject to employment taxes and income tax withholding, and the remaining 30% is tax-free.2Internal Revenue Service. Publication 15-A (2026), Employer’s Supplemental Tax Guide On a $2,000 monthly benefit, that’s $1,400 taxable and $600 not. If the policy has been in force less than three years, the IRS uses whatever years are available, or a reasonable estimate when the policy is under a year old.
Premiums your employer paid on your behalf that were treated as pretax under a cafeteria plan count as employer-paid for this purpose. Only premiums you paid with money that was already taxed give you the tax-free treatment on the benefit side.
Employment Taxes on the Taxable Portion
The taxable share is treated like regular wages for payroll taxes. Social Security tax is 6.2% on both the employee and employer sides, up to the 2026 wage base of $184,500.3Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates Medicare is 1.45% on each side with no cap. FUTA is 6% on the first $7,000 of annual wages, though most employers pay an effective 0.6% after state unemployment credits.4Internal Revenue Service. Topic No. 759, Form 940 – Employers Annual Federal Unemployment (FUTA) Tax Return
If your combined wages and sick pay top $200,000 in a calendar year, the 0.9% Additional Medicare Tax applies as well. Amounts from your employer and the third-party payer are added together to decide whether you’re over the threshold.5Internal Revenue Service. Questions and Answers for the Additional Medicare Tax
FICA and FUTA Stop After Six Months
Social Security, Medicare, and FUTA apply only to sick pay made during the first six calendar months after the last calendar month you actually worked for the employer.6Office of the Law Revision Counsel. 26 U.S. Code 3121 – Definitions After that window closes, later payments are exempt from those taxes.7Internal Revenue Service. Publication 15 (2026), (Circular E), Employer’s Tax Guide The clock runs from your last month on the job, not from when the policy was purchased or when you filed your claim. If you last worked in March, the six-month period covers April through September; payments starting in October are outside FICA and FUTA. Federal income tax withholding can still apply.
Getting Income Tax Withheld
Withholding rules depend on who’s cutting the check. When your employer or its agent pays the sick pay, federal income tax withholding is mandatory and works like normal payroll.2Internal Revenue Service. Publication 15-A (2026), Employer’s Supplemental Tax Guide The portion tied to your own after-tax premium contributions is left out of withholding because it isn’t taxable.
When a non-agent third party pays you — typically an independent insurance company that bears the insurance risk rather than acting as an administrator for your employer — federal income tax withholding is not automatic. You have to ask for it by filing Form W-4S with the payer.8Internal Revenue Service. 2026 Form W-4S Skip this step and nothing comes out of your checks for federal income tax, which can leave you with a large bill and potentially estimated tax penalties at filing time. If your sick pay is coming from an insurance carrier rather than through your employer’s payroll, ask about Form W-4S early.
How It Shows Up on Your W-2
Taxable sick pay appears on Form W-2 alongside your other wages. Box 1 includes the taxable portion. If part of the sick pay is nontaxable because you paid premiums with after-tax dollars, that amount goes in Box 12 with Code J.9Internal Revenue Service. General Instructions for Forms W-2 and W-3 (2026) The “Third-party sick pay” checkbox in Box 13 gets marked to identify the income.
The W-2 can come from either your employer or the third-party payer, depending on how they’ve divided reporting duties. If the insurer handles reporting, you’ll receive a W-2 under the insurer’s name and EIN. If your employer handles it, the W-2 looks like the one you’d normally get. Either way, verify that the taxable and nontaxable splits match what you actually received.
This Is Not Workers’ Compensation
Workers’ compensation covers injuries and illnesses caused by your job, and those payments are fully tax-exempt.10Internal Revenue Service. Publication 525 – Taxable and Nontaxable Income No income tax, no FICA, no FUTA. Third-party sick pay covers non-work causes and is generally taxable unless you paid the premiums yourself with after-tax dollars. If you receive both in the same year, workers’ comp won’t show up in Box 1 of your W-2, and the taxable sick pay will. Treating one like the other is a common way to either overpay tax on exempt income or underreport taxable income.
A Narrow Exclusion for Permanent Injury
Even when sick pay would otherwise be taxable, a limited exclusion covers payments for permanent loss or permanent loss of use of a body part, or permanent disfigurement. Two conditions both have to be met: the payment must be for a permanent physical condition, and the amount must be figured based on the nature of the injury rather than on how long you were out of work.11Office of the Law Revision Counsel. 26 U.S. Code 105 – Amounts Received Under Accident and Health Plans A lump-sum payment for the loss of a finger, calculated from a schedule in the policy, can qualify. A weekly benefit replacing 60% of your salary while you recover from that same injury will not, because it’s tied to lost time rather than the injury itself.