Paper Trails

Third Party Sick Pay

There are a number of different employee benefits. Businesses must know how they work and consider offering them to their employees. This will help in attracting and retaining strong employees. From retirement plans, to health insurance and even third party sick pay, all of these items make up a business’ benefits package. Let’s take a look at what third party sick pay is and how your business can navigate it.

What is third party sick pay?

An employer may offer an employee a designated amount of sick time each calendar year. This pay is used to cover the employee’s lost wages when they are out of work due to illness or a non-job related injury. Workers compensation insurance would be used to cover a job related injury. But what happens when an employee is out of work longer than expected? Or longer than their sick time covers? This is where third party sick pay could come into play.

Third party sick pay is an insurance payment that provides benefits to employees who are out of work due to sickness or a non-job related injury. The main difference between regular sick time and third party sick time is who provides the payments to the employee. With third party sick pay, payments are made to covered employees by a third party. These third parties are known as Third Party Administrators (TPAs). An insurance company is an example of a TPA. While many businesses fund regular sick time themselves, they may use a TPA to fund short-term (STD) or long-term disability (LTD).

How does third party sick pay work?

For companies with established plans, the employer must contact the TPA for payment for a covered employee that misses a period of time due to sickness or non-job related work injury. The employer must provide:

  • Employee’s name and other identifying information (such as a social security number)
  • Employee’s total wages that will be paid during the calendar year
  • Dates the employee last performed work
  • If the employee contributed any after-tax money to their sick pay plan

The TPA will administer a check to the covered employee. This check is only a percentage of the employee’s normal gross pay. Both the employee and employer are required to keep a record of the payments received while the worker is away from the job.

Are these payments taxable?

The answer to whether or not third party sick pay is subject to payroll taxes depends on how the insurance contributions are funded.

  1. If the employer pays 100% of the insurance premiums, then any amount received from a third party by an employee is considered earned income and is taxable.
  2. If the insurance premium is paid by both the employer and employee, then only the percentage that the employer pays is taxable. For example, if the employer covers 75% and the employee covers 25% of the payment, then 75% of the sick pay is taxable.
  3. If the employee covers 100% of the payments with after-tax dollars, then the sick pay is not taxed. This is not common in most insurance plans.

On any payments the are considered taxable, employers must withhold and match FICA taxes (Social Security and Medicare). Employers must also pay Federal Unemployment Tax (FUTA) and State Unemployment Tax (SUTA) on this earned income.

How to report third party sick pay

According to the IRS, if an employer or TPA make sick pay payments, employers must deposit taxes and file the following forms under the same rules that apply to regular wage payments.

  • Form W-2 (regardless if the payments are considered taxable or not)
  • Form W-3
  • IRS Form 940
  • Form 941 or 944

For more information on year-end reporting requirements, check out the IRS Publication 15-A here.