What Is Third-party Sick Pay?

There are a number of paid sick leave laws by state. To stay compliant, some employers have turned to third parties to handle sick pay. Do your employees receive third-party sick pay?

If you offer employees sick pay through a third party, you may have some questions. Is the pay taxable? What are your reporting obligations? Read on to find out. And if you’re unfamiliar with third-party sick pay, you can learn about that as well.  

What is third-party sick pay?

Sick pay is when an employee receives their regular wages even though they are not working due to an illness, injury, or disability. Generally, employers who offer sick pay fund it themselves. But, some employers turn to third parties (e.g., insurance companies) to handle their sick pay for extended periods of times, like short-term or long-term disability

Sometimes, the third party acts as the “employer’s agent,” or third-party administrator. Other times, the third party paying out sick wages is not the employer’s agent. This distinction is important for taxes, which we’ll get into later. 

Unlike sick pay employees receive for missing a day here or there, short-term disability and long-term disability are types of insurance benefits. As a result, employees typically receive a percentage of what they would have earned if they were working. 

Like other types of insurance, employers set up coverage with a third party before an employee needs it. The third party then doles out a percentage of the employee’s wages if the employee qualifies for sick pay. 

What doesn’t count as sick pay?

Sick pay may include short- and long-term benefits, but it doesn’t include everything. According to the IRS, sick pay does not include:

Disability retirement payments Workers’ compensation Medical expense payments Payments unrelated to absence from work (e.g., accident or health insurance payments) Third party sick pay: Taxable or not?

When employers directly provide employees with sick pay, the wages are included in the employee’s total gross wages and taxed. But, sick pay through a third party works a bit differently.

So, is third-party sick pay taxable? Here’s the scoop: 

100% taxable: If you pay 100% of your employee’s sick pay insurance, the entire amount is taxable. This is also true if your employee pays for it with pre-tax dollars.  Partially taxable: If you only pay a portion of the insurance premium, the employee pays taxes on just that amount. For example, if you and your employee each contribute 50% of the premium, 50% of the sick pay is taxable. Nontaxable: If an employee pays for all of their insurance premium using only after-tax income, the sick payments are not taxed.

If sick pay is taxable, it is subject to Social Security, Medicare, FUTA (federal unemployment), and income taxes. 

Who handles the taxes?

OK, OK … so who handles the taxes when you use a third party to distribute sick wages? Do you, or does the third party?

To answer that, we have to go back to the distinction between whether the third party is your “agent” or not. 

Third party: employer’s agent

Employer agents are reimbursed on a cost-plus-fee basis. An agent does not have a direct insurance risk. Instead, they simply provide an administrative service. 

If you have a third party acting as your agent, you are responsible for

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