Third Party Sick Pay

Third-party sick pay refers to income paid to an employee who is unable to work due to illness or non-work-related injury, where the payment is issued not by the employer directly, but by an outside entity. This third party is usually an insurance company or a third-party administrator (TPA) managing the employer’s short-term or long-term disability plan. The purpose of third-party sick pay is to replace lost wages for an employee during extended medical leave. Although the third party issues the payment, employers are typically required to report this compensation on the employee’s Form W-2 and ensure that proper tax handling is in place.

3PSP (Abbreviation for Third-Party Sick Pay)

3PSP is a shorthand abbreviation used in payroll and HR settings to reference Third-Party Sick Pay. The abbreviation streamlines communication in payroll processing systems, compliance documents, and employee benefit discussions. While the abbreviation is informal, it is widely understood in internal payroll contexts. 3PSP refers to the entire process surrounding wage replacement via an insurance provider or TPA, including taxation, benefit eligibility, and year-end reporting.

3rd Party Sick Pay

3rd party sick pay is simply another way to describe third-party sick pay. It refers to the same concept where disability or extended illness compensation is handled by an external provider rather than the employer. This version of the term is commonly used in informal conversations or simplified payroll documentation. Employers offering disability insurance through an external vendor must understand how to track and report 3rd party sick pay properly to ensure compliance with employment tax laws and IRS requirements.

3rd Party Sick Pay on W-2

When an employee receives 3rd party sick pay, that income must be reflected correctly on their Form W-2. Depending on how the disability insurance premiums are funded (by the employer, the employee, or both), the amount reported on the W-2 may vary. If the employer paid all premiums, then 100% of the benefit is taxable and included in the W-2 wages. If the employee paid premiums with after-tax dollars, some or all of the benefit may be excluded from taxable wages. Typically, taxable third-party sick pay is included in Box 1 (wages, tips, and compensation), Box 3 (Social Security wages), and Box 5 (Medicare wages). Employers must also include sick pay in Box 12, using Code “J” if the third party does not withhold Social Security and Medicare taxes. In any case, accurate reporting is critical to ensure both employer and employee tax filings are correct.

3rd Party Sick Pay Reporting

3rd party sick pay reporting involves tracking, verifying, and submitting accurate payroll records regarding payments made by third-party insurance providers on behalf of an employer. These payments usually cover extended disability periods, and the employer must report them on the W-2 even if they were not involved in directly issuing the payments. The third-party provider typically sends periodic notices to the employer detailing payment amounts, tax withholdings, and relevant dates. Employers must incorporate this information into their payroll records and ensure it is reflected accurately in year-end tax documents. Failure to report 3rd party sick pay correctly may lead to tax compliance issues, penalties, or W-2 corrections. For clarity and compliance, it’s best practice to reconcile third-party sick pay notices throughout the year and not wait until the final quarter.

3rd Party Sick Pay Taxes

The taxation of third-party sick pay depends primarily on who paid for the insurance premiums. There are several scenarios that affect the taxability of the sick pay received:

• If the employer fully funded the disability plan, all payments received by the employee are considered taxable income. This includes income tax, Social Security, and Medicare.
• If the employee paid a portion of the plan with after-tax dollars, then only the employer-funded portion of the sick pay is taxable. For example, if the employer paid 60% and the employee paid 40% with post-tax money, only 60% of the benefit is taxable.
• If the employee paid the full premium with post-tax dollars, the benefits are generally not taxable.
• If the employee paid the premium using pre-tax dollars (through a cafeteria plan, for example), then the entire benefit becomes taxable.

Regardless of taxability, if the payment is subject to Social Security and Medicare taxes, the employer is still responsible for matching those amounts and ensuring any unemployment tax obligations are also met. Employers and payroll teams must understand these tax nuances to prevent errors in withholdings and filings.