Third Party Sick Pay: What Payroll Must Know to Tax and ... · Payments attributable to employee...

Presented on Friday, February 10, 2017

Third Party Sick Pay: What Payroll Must Know to Tax

and Report Correctly

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What is third party sick pay

When is the third party not the employer’s agent and when are they

How does the status of the employer’s agent affect the taxation and reporting of third party sick pay

When is third party sick pay taxable for income tax

When is third party sick pay taxable for FICA and FUTA

When is third party sick pay nontaxable

Who reports the payments for third party sick pay for such forms as the 941 and W-2

What happens to the taxation if the employee pays a portion of the premium

What Is Our Focus For Today?

©2017 The Payroll Advisor

5

Vicki M. Lambert, CPP, is President and Academic Director of The Payroll Advisor™, a firm specializing in payroll education and training. The company’s website www.thepayrolladvisor.comoffers a subscription payroll news service which keeps payroll professionals up-to-date on the latest rules and regulations.

Today’s Presenter

Vicki M. Lambert CPP

http://www.thepayrolladvisor.com/

Sick Pay

7

Employers may provide their employees with paid “sick leave” “sick days” or “PTO”

Ensures that the employee will receive their regular salary for brief absences due to illness or injury

Made from regular payroll account

Taxable wages subject to FIT, FICA and FUTA

Third-Party Sick Pay is not “sick pay” in this sense


Definition of Third-Party Sick Pay

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Plan or system established by an employer for all employees or specific classes of employees

In writing or otherwise known to employees

Offered through an established contract usually with an insurance company

Employee is temporarily absent due to injury, sickness or disability

Includes both short-term and long-term disability benefits

Often expressed as a % of employee’s wages


Third-Party Sick Pay is Not…

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Disability retirement payments

Workers’ compensation

Medical expense payments

Payments unrelated to absence from work under health insurance or accident plans

State Disability Insurance


Compliance Factors…

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Taxation and reporting requirements for third party sick pay depends on several factors:

Is it the employer?

Is it the employer’s agent?

Is it a third party—not the employer’s agent?

Has liability been transferred back to employer?

What has been agreed to?

Need to be in on the negotiations!


Definition of Employer’s Agent

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Employer contracts with a third party to administer its disability plan

Employer pays the third party on a cost-plus-fee basis

Employer retains the insurance risk

No premiums are paid to the third party


Third-Party Not Employer’s Agent

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Employer contracts with third-party insurer to make disability payments to its employees

Third-Party bears the risk of insuring the employees--Paid premium by employer and/or employee

The third party is also liable for the employer part of the social security and Medicare taxes and the FUTA tax, unless the third party transfers this liability to the employer for whom the employee normally works


Transferring Liability

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Withholds the employee social security and Medicare taxes from the sick pay payments.

Makes timely deposits of the employee social security and Medicare taxes.

Notifies the employer for whom the employee normally works of the payments on which employee taxes were withheld and deposited

The third party must notify the employer within the time required for the third party's deposit of the employee part of the social security and Medicare taxes.


Transferring Liability

14

If the third party is a monthly schedule depositor, it must notify the employer by the 15th day of the month following the month in which the sick pay payment is made because that is the day by which the deposit is required to be made. The third party should notify the employer as soon as information on payments is available so that an employer required to make electronic deposits can make them timely.


Taxable Wages

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Depends on how plan benefits are funded

Benefits attributable to employer contributions or to employee pretax contributions through a cafeteria plan are taxable income to the employee

Where both the employee and employer contribute to the premium—taxable portion attributable to the employer-funded portion of the premiums


Taxable Income Under Group Policy

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If both the employer and employee contribute to the sick pay plan under a group insurance policy taxable income is determined by calculation:

Employee’s sick pay x employer-paid premiums

total premiums last 3 years


Example

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Alan is employed by Groundforce Corporation. Because of an illness, he was absent from work for three months during 2016. Groundforce Corporation paid Alan $2,000 sick pay for each month of his absence under a policy paid for by contributions from both Groundforce and its employees. All of the employees' contributions were paid with after-tax dollars.


Example

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For the three policy years before 2016, Groundforce paid $60,000 or 70% of the policy's cost and its employees paid $26,000 or 30%.

Because 70% of the sick pay paid under the policy is due to Groundforce's contributions, $1,400 ($2,000 × 70%) of each payment made to Alan is taxable sick pay. The remaining $600 of each payment that is due to employee contributions is not taxable sick pay.


When Nontaxable for FICA and FUTA

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The following payments, whether made by the employer or a third party, are not subject to social security, Medicare, or FUTA taxes:


Payments After Employee's Death Or Disability Retirement

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Social security, Medicare, and FUTA taxes do not apply to amounts paid under a definite plan or system, as defined earlier, on or after the termination of the employment relationship because of death or disability retirement.

However, even if there is a definite plan or system, amounts paid to a former employee are subject to social security, Medicare, and FUTA taxes if they would have been paid even if the employment relationship had not terminated because of death or disability retirement.

For instance, a payment to a disabled former employee for unused vacation time would have been made whether or not the employee retired on disability. Therefore, the payment is wages and is subject to social security, Medicare, and FUTA taxes.


Payments After Calendar Year Of Employee's Death

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Sick pay paid to the employee's estate or survivor after the calendar year of the employee's death is not subject to social security, Medicare, or FUTA taxes.

Example: Delila became entitled to sick pay on November 24, 2016, and died on December 31, 2016. On January 12, 2017, Delila's sick pay for the period from December 24 through December 31, 2016, was paid to her survivor. The payment is not subject to social security, Medicare, or FUTA taxes.


Payments to an employee entitled to disability insurance benefits

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Payments to an employee when the employee is entitled to disability insurance benefits under section 223(a) of the Social Security Act are not subject to social security and Medicare taxes. This rule applies only if the employee became entitled to the Social Security Act benefits before the calendar year in which the payments are made, and the employee performs no services for the employer during the period for which the payments are made. These payments are subject to FUTA tax.


Payments that exceed the applicable wage base

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Social security and FUTA taxes do not apply to payments of sick pay that, when combined with the regular wages and sick pay previously paid to the employee during the year, exceed the applicable wage base. Because there is no Medicare tax wage base, this exception does not apply to Medicare tax. The social security tax wage base for 2017 is $127,200. The FUTA tax wage base is $7,000.

Example: If an employee receives $120,000 in wages from an employer in 2017 and then receives $15,000 of sick pay, only the first $7,200 of the sick pay is subject to social security tax. All of the sick pay is subject to Medicare tax. None of the sick pay is subject to FUTA tax.


Payments after 6 months absence from work

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Social security, Medicare, and FUTA taxes do not apply to sick pay paid more than 6 calendar months after the last calendar month in which the employee worked.

Example 1: Charlie’s last day of work before he became entitled to receive sick pay was December 11, 2015. He was paid sick pay for nine months before his return to work on September 14, 2016. Sick pay paid to Charlie after June 30, 2016, is not subject to social security, Medicare, or FUTA taxes.

Example 2: The facts are the same as in Example 1, except that Charlie worked 1 day during the 9-month period, on February 12, 2016. Because the 6-month period begins again in March, only the sick pay paid to Charlie after August 31, 2016, is exempt from social security, Medicare, and FUTA taxes.


Payments attributable to employee contributions

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Social security, Medicare, and FUTA taxes do not apply to payments, or parts of payments, attributable to employee contributions to a sick pay plan made with after-tax dollars.

Contributions to a sick pay plan made on behalf of employees with employees' pretax dollars under a cafeteria plan are employer contributions.


Third Party FICA and FUTA

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Must withhold and pay-over employee’s share of social security and Medicare taxes

Responsible for employer’s share of FICA taxes unless it transfers liability back to employer

Responsible for FUTA unless it transfers liability back to employer


FIT Withholding

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The requirements for income tax withholding on sick pay and the methods for figuring it differ depending on whether the sick pay is paid by:

The employer,

An agent of the employer

A third party that is not the employer's agent.


FIT Taxation

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The following amounts paid either by employer/agent or third party are not subject to FIT:

Sick pay paid to the employee's estate or survivor at any time after the employee's death is not subject to income tax withholding, regardless of who pays it

Payments, or parts of payments, attributable to employee contributions made to a sick pay plan with after-tax dollars are not subject to income tax withholding


Paid by Employer or Employer’s Agent

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Withholding is mandatory

Withhold based on the employee’s most recent Form W-4

Cannot use Form W-4S

Employee cannot choose how much to withhold

If agent does not pay regular wages to employee it may treat as supplemental wages and tax at 25% or 39.6% if employee’s year-to-date supplemental wages exceed $1 million


Paid by a Third Party Not an Agent

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Assumes greater role in the area of tax responsibility

Not required to withhold FIT from payments unless employee requests it

Employee must submit Form W-4S

Must begin withholding within 8 days after W-4S is provided


Form W-4S

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Request for Federal Income Tax Withholding From Sick Pay

Only used by Third-Party agents

Must be completed in whole dollars

Must be at least $4/day, $20/week or $88/month

Employee must receive at least $10 pay

Must allow employee to request a percentage if they used one on normal payroll –form does not provide for percentage withholding

Minimum 10%


Depositing Taxes

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General deposit rules apply but liability varies depending on who has responsibility

Employer/Agent: liability begins at the time payment is made

EIN used depends on agreement between agent and employer

If agent assumes some of employer responsibilities then they should deposit using their own EIN and name

If agent does not assume any responsibilities then deposits under employer name and EIN


Depositing Taxes…

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Third Party

If the liability is not transferred back to the employer

Liability begins at the time payment is made

Third Party uses own name and EIN


Depositing Taxes…

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Employer Third Party Liability Transferred Back: employer liable when notified timely by third party as to amount of payments made and employee FICA taxes withheld and deposited


Reporting Sick Pay Paid by Employer or Agent

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If the employer or its agent made sick pay payments, the employer files Forms W-2, W-3, 940 and 941 under the same rules that apply to regular wage payments. However, the agreement between the parties may require the agent to carry out responsibilities that would otherwise have been borne by the employer. In this situation, the agent should use its own name and EIN (rather than the employer’s) for the responsibilities it has assumed.


Form W-2 For Employer/Agent

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Employers may either combine the sick pay with other wages and prepare a single Form W-2 for each employee or prepare separate Forms W-2 for each employee, one reporting sick pay and the other reporting regular wages. A Form W-2 must be prepared even if all the sick pay is nontaxable. The Form W-2 filed for the sick pay must include the employer's name, address, and EIN; the employee's name, address, and SSN; and the following information:


Form W-2 for Employer/Agent

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Box 1 - Sick pay the employee must include in income

Box 2 - Any Federal income tax withheld from the sick pay

Box 3 - Sick pay subject to employee Social Security tax

Box 4 - Employee social security tax withheld from the sick pay

Box 5 - Sick pay subject to employee Medicare tax

Box 6 - Employee Medicare tax withheld from the sick pay

Box 12 - Any amount not subject to Federal income tax because the employee contributed to the sick pay plan (enter code J)

Box 13 “Third-party sick pay” is checked only if the amounts were paid by a third party


Reporting Sick Pay Paid by Third Party

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The third party must give each employee to whom it paid sick pay a Form W-2 by January 31 of the following year

The Form W-2 must include the third party's name, address, and EIN instead of the employer information. Otherwise, the third party must complete Form W-2 the same as the employer or agent


If Liability is Transferred Back

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Sick Pay Statement: The third party must furnish the employer with a sick pay statement by January 15 of the year following the year in which the sick pay was paid. The statement must show the following information about each employee who was paid sick pay:


Sick Pay Statement

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The employee's name

The employee's SSN (if social security, Medicare, or income tax was withheld)

The sick pay paid to the employee

Any federal income tax withheld

Any employee social security tax withheld

Any employee Medicare tax withheld


Optional Reporting Rule for Form W-2

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The employer and the third party may choose to enter into a legally binding agreement designating the third party to be the employer’s agent for purposes of preparing Forms W-2 reporting sick pay

If an employer enters into an agreement, the third party prepares the actual Forms W-2 for each employee who receives sick pay from the third party

Employer must file “Third-Party Sick Pay Recap” Form 8922


Third-Party Recap Form 8922

43

The employer must prepare a third-party sick pay recap Form 8922—since 2014

Show the combined amount of sick pay paid to all employees of all clients of the third party.

These recap forms are needed to reconcile the sick pay shown on the employer’s Forms 941 or Form 944.


©2017 The Payroll Advisor44

Third-Party Recap Form 8922

Form 941

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Will include taxable income on lines 2, 5a, 5c and 5d

Adjustments are made on line 8 for 2017


Form 941 Employer/Agent


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Employer or agent completes the Form 941 as usual depending on agreement between two parties as to responsibility

Form 941 Liability not Transferred to Employer

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If the third party does not satisfy the requirements for transferring liability for FUTA tax and the employer's part of the social security and Medicare taxes, the third party reports the sick pay on its own Forms 940 and 941. In this situation, the employer has no tax responsibilities for sick pay.


Form 941 Liability Transferred to Employer


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The third party and the employer must each file Form 941. Line 8 of each Form 941 must contain a special adjusting entry for Social Security and Medicare taxes. These entries are required because the total tax liability for Social Security and Medicare taxes (employee and employer parts) is split between the employer and the third party


The FICA is doubled

for calculation here

as normal

Back out

noncollected/paid here49

Practical Point

50

A third party that pays sick pay should request information from the employer to determine amounts that are not subject to employment taxes. Unless the third party has reason not to believe the information, it may rely on that information as to the following items:

The total wages paid the employee during the calendar year.

The last month in which the employee worked for the employer.

The employee contributions to the sick pay plan made with after-tax dollars.


Example

51

Jodie, an employee, was seriously injured in a car accident on January 1, 2016. Jodie's last day of work was December 31, 2015. The accident was not job related.

Acme, an insurance company that was not an agent of the employer, paid Jodie $2,000 each month for 10 months, beginning in January 2016. Jodie submitted a Form W-4S to Acme, requesting $210 be withheld from each payment for federal income tax. Jodie received no payments from Cedaroak, her employer, from January 2016 through October 2016. Jodie returned to work on November 2, 2016.


Example Continued

52

For the policy year in which the car accident occurred, Jodie paid a part of the premiums for her coverage, and Cedaroak paid the remaining part. The plan was, therefore, a contributory plan.During the 3 policy years before the calendar year of the accident, Cedaroakpaid 70% of the total of the net premiums for its employees' insurance coverage, and its employees paid 30%.


Social Security and Medicare

53

For social security and Medicare tax purposes, taxable sick pay was $8,400 ($2,000 per month × 70% = $1,400 taxable portion per payment; $1,400 × 6 months = $8,400 total taxable sick pay). Only the six $2,000 checks received by Jodie from January through June are included in the calculation. The check received by Jodie in July (the seventh check) was received more than 6 months after the month in which Jodie last worked.

Of each $2,000 payment Jodie received, 30% ($600) is not subject to social security and Medicare taxes because the plan is contributory and Jodie's after-tax contribution is considered to be 30% of the premiums during the 3 policy years before the calendar year of the accident.


Income Tax Withholding

54

Of each $2,000 payment, $1,400 ($2,000 × 70%) is subject to voluntary income tax withholding. In accordance with Jodie's Form W-4S, $210 was withheld from each payment ($2,100 for the 10 payments made during 2016).


FUTA Tax

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Of the $8,400 taxable sick pay (figured the same as for social security and Medicare taxes), only $7,000 is subject to the FUTA tax because the FUTA contribution base is $7,000.


Liability Transferred Example

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Acme could have shifted liability for employer part of social security and Medicare taxes during first 6 months by withholding Jodie’s part of FICA taxes, timely depositing taxes and notifying Cedaroak of the payments

Cedaroak pays employer FICA upon receiving notification from Acme

If liability shifted Acme provides sick pay statement to Cedaroak

Cedaroak prepares Form W-2 for JodieAcme prepares Form 8922Same applies for FUTA


Liability Not Transferred Example

57

If Acme does not transfer liability for FICA taxes, Acme prepares Forms W-2 and W-3

Cedaroak does not report the sick pay

Same applies for FUTA


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Third Party Sick Pay: What Payroll Must Know to Tax and ... · Payments attributable to employee...

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