Excerpt From Our Online Payroll Compliance Course

Social Security, Medicare, And FUTA Taxes On Sick Pay

Third-party sick pay is subject to federal taxation in some cases, but not in all instances.

The taxation requirements depend on many factors including:

The length of time the employee receives sick pay
Who is paying the premiums
Who is paying the sick pay
How much is paid, and
When and why the payment was made

The following rules and definitions apply to social security, Medicare, and FUTA taxes on sick pay.

Employer
If the employer pays sick pay to the employee, the employer must generally withhold employee social security and Medicare taxes from the sick pay.

The employer must timely deposit employee and employer social security, Medicare and FUTA taxes. There are no special deposit rules for sick pay.

Amounts Not Subject To Social Security, Medicare, Or FUTA Taxes
The following payments, whether made by the employer or a third party, are not subject to social security, Medicare, or FUTA taxes (different rules apply to income tax withholding):

Payments After Employee's Death Or Disability Retirement
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
Sick pay paid to the employee's estate or beneficiary after the calendar year of the employee's death is not subject to social security, Medicare, or FUTA taxes
Payments To An Employee Entitled To Disability Insurance Benefits
Payments to an employee when the employee is entitled to disability insurance benefits under §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
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 bases. Because there is no Medicare tax wage base, this exception does not apply to Medicare tax.
Payments After Six-Months Absence From Work
Social security, Medicare, and FUTA taxes do not apply to sick pay paid more than six calendar months after the last calendar month in which the employee worked.
Payments Attributable To Employee Contributions
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.
Group Policy
If both the employer and the employee contributed to the sick pay plan under a group insurance policy, calculate the taxable sick pay by multiplying amount by the percentage of the policy's cost that was contributed by the employer for the three policy years before the calendar year in which the sick pay is paid.

If the policy has been in effect fewer than three years, use the cost for the policy years in effect or, if in effect less than one year, a reasonable estimate of the cost for the first policy year.

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