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
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
©2017 The Payroll Advisor
Definition of Third-Party Sick Pay
8
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
©2017 The Payroll Advisor
Third-Party Sick Pay is Not…
9
Disability retirement payments
Workers’ compensation
Medical expense payments
Payments unrelated to absence from work under health insurance or accident plans
State Disability Insurance
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Compliance Factors…
10
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!
©2017 The Payroll Advisor
Definition of Employer’s Agent
11
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
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Third-Party Not Employer’s Agent
12
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
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Transferring Liability
13
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.
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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.
©2017 The Payroll Advisor
Taxable Wages
15
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
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Taxable Income Under Group Policy
16
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
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Example
17
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.
©2017 The Payroll Advisor
Example
18
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.
©2017 The Payroll Advisor
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:
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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.
©2017 The Payroll Advisor
Payments After Calendar Year Of Employee's Death
21
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.
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Payments to an employee entitled to disability insurance benefits
22
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.
©2017 The Payroll Advisor
Payments that exceed the applicable wage base
23
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.
©2017 The Payroll Advisor
Payments after 6 months absence from work
24
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.
©2017 The Payroll Advisor
Payments attributable to employee contributions
25
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.
©2017 The Payroll Advisor
Third Party FICA and FUTA
26
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
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FIT Withholding
27
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.
©2017 The Payroll Advisor
FIT Taxation
28
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
©2017 The Payroll Advisor
Paid by Employer or Employer’s Agent
29
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
©2017 The Payroll Advisor
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
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Form W-4S
31
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%
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32©2017 The Payroll Advisor
Depositing Taxes
33
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
©2017 The Payroll Advisor
Depositing Taxes…
34
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
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Depositing Taxes…
35
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
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Reporting Sick Pay Paid by Employer or Agent
36
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.
©2017 The Payroll Advisor
Form W-2 For Employer/Agent
37
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:
©2017 The Payroll Advisor
Form W-2 for Employer/Agent
38
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
©2017 The Payroll Advisor
Reporting Sick Pay Paid by Third Party
39
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
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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:
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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
©2017 The Payroll Advisor
Optional Reporting Rule for Form W-2
42
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
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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 Advisor
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Third-Party Recap Form 8922
Form 941
45
Will include taxable income on lines 2, 5a, 5c and 5d
Adjustments are made on line 8 for 2017
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Form 941 Employer/Agent
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46
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
47
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.
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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
©2017 The Payroll Advisor
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.
©2017 The Payroll Advisor
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.
©2017 The Payroll Advisor
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%.
©2017 The Payroll Advisor
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.
©2017 The Payroll Advisor
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).
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FUTA Tax
55
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.
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Liability Transferred Example
56
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
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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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