How to Report Third-Party Sick Pay to the IRS
Author: Alice Gilman
An employee who receives sick pay - long-term or short-term disability pay - from an employer or a third party, such as an employer's agent or an insurance company, is required to pay Social Security and Medicare (FICA) taxes on the amounts received. Federal income tax withholding is mandatory or voluntary, depending on the payer. Although sick pay is taxable to the employee, and the employer must pay its matching share of FICA taxes, under special rules the employer and the third party may transfer liability between themselves for withholding, depositing and reporting the taxes attributable to the sick pay.
Third-party sick pay is reported on Form 8922, Third-Party Sick Pay Recap, if the liability for the employer's portion of FICA taxes has been transferred between the employer and the employer's third party. Whether the third party or the employer reports the sick pay on Form 8922 depends on the entity that is filing Forms W-2 reporting the sick pay paid to individual employees.
Step 1: Identify Whether Sick Pay Is Paid Under a Plan
Sick pay includes amounts paid under a plan because of an employee's temporary absence from work due to injury, sickness or disability. Sick pay is not the same as sick days, which may be paid or unpaid according to an employer's policy.
A sick pay plan is a plan or system established by an employer under which sick pay is available to employees generally, or to a class or classes of employees. An employer has a sick pay plan or system if the plan is in writing or it is somehow communicated to employees, such as by posting a notice on a bulletin board. Alternatively, an employer may have a long and established practice of paying sick pay. Some indications that an employer has a sick pay plan or system include references to it in an employment contract or employee handbook, the employer's contributions into the plan or the employer establishing segregated accounts from which benefits are paid.
Step 2: Identify the Entity That Pays the Sick Pay
Sick pay may be paid by the employer or a third party, such as an insurance company. A third party may or may not be the employer's agent. A third party is the employer's agent if the third party bears no insurance risk and is reimbursed on a cost-plus-fee basis for the payment of sick pay. A third party may be an employer's agent even if the third party is responsible for determining the employees who are eligible to receive sick pay. However, a third party is not the employer's agent if the third party is paid insurance premiums and is not reimbursed on a cost-plus-fee basis.
Under Acme Widget Company's contract with General Insurance Company (GIC), GIC will provide only administrative services related to Acme's long-term disability plan. GIC is Acme's third-party agent.
Step 3: Apportion the Tax Responsibilities
Sick pay is subject to mandatory federal income tax withholding, as if it were regular wages, if paid to an employee by an employer or an employer's agent. Sick pay is subject to voluntary income tax withholding if paid by a third party who is not an employer's agent; the employee files Form W-4S, Request for Federal Income Tax Withholding From Sick Pay, with the third party to indicate the amount to withhold. Sick pay is subject to mandatory FICA tax withholding.
Liability for withholding, depositing and reporting FICA taxes may be transferred between the employer and the third party.
Third-party agent. A third party that makes payments of sick pay as an employer's agent generally has no responsibility to withhold and deposit income and FICA taxes. This responsibility remains with the employer. However, the employer and the agent may enter into an agreement that makes the third-party agent responsible for withholding and depositing the taxes.
Third party not an agent. A third party that makes payments of sick pay not as the employer's agent (e.g., an insurance company) is responsible for withholding income taxes (if requested by the employee) and the employee's share of FICA taxes. The third party is liable for the employer's matching share of FICA taxes, unless the third party transfers liability for the employer's share of FICA to the employer by taking these steps:
- The third party withholds the employee's portion of FICA;
- The third party timely deposits the employee's portion of FICA; and
- The third party notifies the employer of the payments on which employee taxes were withheld and deposited.
If liability is transferred, the employer must pay its matching share of FICA that is attributable to the sick pay. The employer must also report this amount on its Form 941, Employers Quarterly Federal Tax Return. The third party is responsible for depositing and reporting any federal income taxes withheld, plus the employee's share of FICA to the IRS on its Form 941.
For Form W-2, Wage and Tax Statement, reporting purposes, if the third party transfers liability to the employer, the employer becomes responsible for completing the employee's Form W-2 with respect to the sick pay and other wages the employee earned during the year. Under another, optional, rule the employer and the third party may agree that the third party becomes the employer's agent for purposes of filing Form W-2.
During the first quarter of 2015, Paul Landesman, an employee of Acme Corp., received $5,000 in taxable sick pay from Acme's third party - Reliable Insurance Company, which is not Acme's agent. Landesman also earned $10,000 in wages during the first quarter of 2015, and a total of $40,000 in wages for the year.
Reliable withheld Landesman's share of FICA taxes from the $5,000 in sick pay, and also withheld federal income tax as requested by Landesman on Form W-4S. Reliable deposited those taxes and provided Acme with timely notice of the amount of wages paid on which the taxes were withheld and deposited.
By taking these steps, Reliable transferred to Acme the liability for the employer portion of FICA taxes on the sick pay and the obligation to file Form W-2 with respect to the sick pay.
Step 4: Decide Whether to File Form 8922
If there is no split reporting of sick pay on Forms 941, there is no obligation to file Form 8922. However, since two different parties - the employer or the third party - may pay sick pay to an employee during the year, a year-end reconciliation becomes necessary. Form 8922 is used for this purpose. The requirement to file Form 8922 can arise in one of these situations:
- The third party files Form 8922 when it is liable for withholding the employee's portion of FICA taxes, regardless of whether it is also liable for the employee's income tax withholding, but the liability for the employer's share of FICA, and for reporting sick pay on Forms W-2, is transferred to the employer.
- The employer files Form 8922 when the third party withholds both the employee's income taxes and his or her share of FICA,and the liability for the employer's share of FICA is transferred to the employer, and the employer and third party have agreed to have the third party act as the employer's agent for Form W-2 reporting purposes.
- A third party who is an employer's agent is required to file Form 8922 when the agreement between it and the employer provides that the agent will withhold and pay the employee's share of FICA and report those taxes on its Form 941, and the employer will pay the employer's share of FICA, report the those taxes on its Form 941 and also report the employee's wages on Form W-2.
Step 5: Complete Form 8922
Form 8922 does not show the names of individuals who received third-party sick pay. It only shows the total amounts paid in the calendar year to all employees whose sick pay wages are required to be reported on Form 8922.
A third party who is an employer's agent is required to report sick pay on Form 8922 only if the agency agreement between the employer and the agent imposes the following requirements:
- The agent agrees to withhold and pay the employee's federal income and FICA taxes; and
- The agent agrees to report the withheld amounts on Form 941, using the agent's name and Employer Identification Number (EIN).
The agreement must also require the employer to pay and report the employer's share of FICA on its Form 941, using the employer's name and EIN and to report the sick pay on the employee's Form W-2.
The taxpayer required to file Form 8922 (i.e., the employer or the third party) includes its name, address and telephone number as the filer's name. If the employer files Form 8922, it shows the name and EIN of the third party paying the sick pay for which there is split reporting.
- In Box 1, report the sick pay that is subject to federal income taxes;
- In Box 2, report the federal income tax withheld, if any, from the sick pay;
- In Box 3, report sick pay subject to social security taxes;
- In Box 4, report the social security taxes that were withheld from sick pay; and
- In Box 5, report sick pay subject to Medicare taxes.
Reliable Insurance Company and Landesman's employer complete Forms 941, W-2, W-3 and Form 8922 with respect to Landesman as follows:
Acme Corp. On its first-quarter 2015 Form 941, Acme includes Landesman's $15,000 of wages on Line 2. It does not include the amount of federal income tax withheld by Reliable on Line 3, since Reliable must include it on its Form 941. Acme, however, includes Landesman's total quarterly wages on Lines 5a (social security tax) and 5c (Medicare tax). Since Reliable withheld and deposited Landesman's share of FICA taxes on the $5,000 of sick pay, Acme reports an adjustment in the amount of the employee FICA taxes withheld on the sick pay on Line 8 (Current quarter's adjustment for sick pay).
At the end of 2015, Acme issues a Form W-2 to Landesman. The form combines the $40,000 of wages it paid and the $5,000 of sick pay from Reliable. The form also combines the income and FICA taxes withheld by both corporations in reporting the taxes withheld on Form W-2.
Acme does not file Form 8922 with respect to the sick pay paid by Reliable because Acme is fulfilling the Form W-2 reporting requirements to Landesman with respect to the wages.
Reliable Insurance Company. On its first-quarter 2015 Form 941, Reliable does not include the $5,000 sick pay it paid to Landesman on Line 2. It includes the amount of federal income tax withholding that Landesman requested on Line 3. The sick pay it paid to Landesman is also included on Lines 5a and 5c. Since it transferred liability for the employer's share of FICA taxes to Acme, it adjusts the FICA taxes on Line 8.
Since the employer's share of FICA taxes on the third-party sick pay is reported on Acme's Form 941 and the sick pay is reported on Forms W-2 issued by Acme, Reliable must prepare and file Form 8922 to report the sick pay it paid to Acme's employees. Reliable must file the form with the IRS on paper by March 1, 2016.