Publication 15-A
Employer's Supplemental Tax Guide
(Revised: 1/2003)

(Supplement to Circular E, Employer's Tax Guide (Publication 15))

SIMPLE Retirement Plans

Employer and employee contributions to a savings incentive match plan for employees (SIMPLE) retirement account (subject to limitations) are excludable from the employee's income and are exempt from Federal income tax withholding. An employer's nonelective (2%) or matching contributions are exempt from social security, Medicare, and FUTA taxes. However, an employee's salary reduction contributions to a SIMPLE are subject to social security, Medicare, and FUTA taxes. For more information about SIMPLE retirement plans, see Pub. 560.

6. Sick Pay Reporting

Special rules apply to the reporting of sick pay payments to employees. How these payments are reported depends on whether the payments are made by the employer or a third party, such as an insurance company.

Sick pay is usually subject to social security, Medicare, and FUTA taxes. For exceptions, see Social Security, Medicare, and FUTA Taxes on Sick Pay later. Sick pay also may be subject to either mandatory or voluntary Federal income tax withholding, depending on who pays it.

Sick Pay

Sick pay generally means any amount paid under a plan because of an employee's temporary absence from work due to injury, sickness, or disability. It may be paid by either the employer or a third party, such as an insurance company. Sick pay includes both short- and long-term benefits. It is often expressed as a percentage of the employee's regular wages.

Payments That Are Not Sick Pay

Sick pay does not include the following payments:

1. Disability retirement payments. Disability retirement payments are not sick pay and are not discussed in this section. Those payments are subject to the rules for income tax withholding from pensions and annuities. See section 8.
2. Workers' compensation. Payments because of a work-related injury or sickness that are made under a workers' compensation law are not sick pay and are not subject to employment taxes. But see Workers' Compensation - Public Employees in section 5.
3. Medical expense payments. Payments under a definite plan or system for medical and hospitalization expenses, or for insurance covering these expenses, are not sick pay and are not subject to employment taxes.
4. Payments unrelated to absence from work. Accident or health insurance payments unrelated to absence from work are not sick pay and are not subject to employment taxes. These include payments for:
   1. Permanent loss of a member or function of the body,
   2. Permanent loss of the use of a member or function of the body, or
   3. Permanent disfigurement of the body.

   Example. Donald was injured in a car accident and lost an eye. Under a policy paid for by Donald's employer, Delta Insurance Co. paid Donald $5,000 as compensation for the loss of his eye. Because the payment was determined by the type of injury and was unrelated to Donald's absence from work, it is not sick pay and is not subject to employment taxes.

Sick Pay Plan

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. This does not include a situation in which benefits are provided on a discretionary or occasional basis with merely an intention to aid particular employees in time of need.

You have a sick pay plan or system if the plan is in writing or is otherwise made known to employees, such as by a bulletin board notice or your long and established practice. Some indications that you have a sick pay plan or system include references to the plan or system in the contract of employment, employer contributions to a plan, or segregated accounts for the payment of benefits.

Definition of employer.   The employer for whom the employee normally works, a term used in the following discussion, is either the employer for whom the employee was working at the time the employee became sick or disabled or the last employer for whom the employee worked before becoming sick or disabled, if that employer made contributions to the sick pay plan on behalf of the sick or disabled employee.

Note:   Contributions to a sick pay plan through a cafeteria plan (by direct employer contributions or salary reduction) are employer contributions unless they are aftertax employee contributions (included in taxable wages).

Third-Party Payers of Sick Pay

Employer's agent.   An employer's agent is a third party that bears no insurance risk and is reimbursed on a cost-plus-fee basis for payment of sick pay and similar amounts. A third party may be your agent even if the third party is responsible for determining which employees are eligible to receive payments. For example, if a third party provides administrative services only, the third party is your agent. If the third party is paid an insurance premium and is not reimbursed on a cost-plus-fee basis, the third party is not your agent. Whether an insurance company or other third party is your agent depends on the terms of the agreement with you.

A third party that makes payments of sick pay as your agent is not considered the employer and generally has no responsibility for employment taxes. This responsibility remains with you. However, under an exception to this rule, the parties may enter into an agreement that makes the third-party agent responsible for employment taxes. In this situation, the third-party agent should use its own name and EIN (rather than your name and EIN) for the responsibilities it has assumed.

Third party not employer's agent.   A third party that makes payments of sick pay other than as an agent of the employer is liable for income tax withholding (if requested by the employee) and the employee part of the social security and Medicare taxes. 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. This liability is transferred if the third party takes the following steps:

1. Withholds the employee social security and Medicare taxes from the sick pay payments.
2. Makes timely deposits of the employee social security and Medicare taxes.
3. 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. For instance, 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. For multi-employer plans, see the special rule discussed next.

Multi-employer plan timing rule.   A special rule applies to sick pay payments made to employees by a third-party insurer under an insurance contract with a multi-employer plan established under a collectively bargained agreement. If the third-party insurer making the payments complies with steps 1 and 2 above and gives the plan (rather than the employer) the required timely notice described in step 3 above, then the plan (not the third-party insurer) must pay the employer part of the social security and Medicare taxes and the FUTA tax. Similarly, if, within 6 business days of the plan's receipt of notification, the plan gives notice to the employer for whom the employee normally works, the employer (not the plan) must pay the employer part of the social security and Medicare taxes and the FUTA tax.

Reliance on information supplied by the employer.   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 aftertax dollars.

The third party should not rely on statements regarding these items made by the employee.

Social Security, Medicare, and FUTA Taxes on Sick Pay

Employer.   If you pay sick pay to your employee, you must generally withhold employee social security and Medicare taxes from the sick pay. You must timely deposit employee and employer social security and Medicare taxes and FUTA tax. There are no special deposit rules for sick pay. See section 11 of Circular E for more information on the deposit rules.

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 under Sick Pay Plan 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 example, 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 survivor after the calendar year of the employee's death is not subject to social security, Medicare, or FUTA taxes. (Also, see Amounts not subject to income tax withholding under Income Tax Withholding on Sick Pay later.)

  Example. Sandra became entitled to sick pay on November 29, 2002, and died on December 26, 2002. On January 15, 2003, Sandra's sick pay for the period from December 19 through December 26, 2002, 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. 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. 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 2003 is $87,000. The FUTA tax wage base is $7,000.

  Example. If an employee receives $80,000 in wages from an employer in 2003 and then receives $10,000 of sick pay, only the first $7,000 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. See Example of Figuring and Reporting Sick Pay later.

• Payments after 6 months absence from work. 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. Ralph's last day of work before he became entitled to receive sick pay was December 9, 2002. He was paid sick pay for 9 months before his return to work on September 8, 2003. Sick pay paid to Ralph after June 30, 2003, is not subject to social security, Medicare, or FUTA taxes.

  Example 2. The facts are the same as in Example 1, except that Ralph worked 1 day during the 9-month period, on February 14, 2003. Because the 6-month period begins again in March, only the sick pay paid to Ralph after August 31, 2003, is exempt from social security, Medicare, and FUTA taxes.

• 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 aftertax 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, figure the taxable sick pay by multiplying it by the percentage of the policy's cost that was contributed by the employer for the 3 policy years before the calendar year in which the sick pay is paid. If the policy has been in effect fewer than 3 years, use the cost for the policy years in effect or, if in effect less than 1 year, a reasonable estimate of the cost for the first policy year.

  Example. Alan is employed by Edgewood Corporation. Because of an illness, he was absent from work for 3 months during 2003. Key Insurance Company paid Alan $2,000 sick pay for each month of his absence under a policy paid for by contributions from both Edgewood and its employees. All the employees' contributions were paid with aftertax dollars. For the 3 policy years before 2003, Edgewood paid 70% of the policy's cost and its employees paid 30%. Because 70% of the sick pay paid under the policy is due to Edgewood'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 and is not subject to employment taxes. Also, see Example of Figuring and Reporting Sick Pay later.

Income Tax Withholding on Sick Pay

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 (defined earlier), or
• A third party that is not the employer's agent.

Employer or employer's agent.   Sick pay paid by you or your agent is subject to mandatory income tax withholding. An employer or agent paying sick pay generally determines the income tax to be withheld based on the employee's Form W-4. The employee cannot choose how much will be withheld by giving you or your agent a Form W-4S, Request for Federal Tax Withholding From Sick Pay. Sick pay paid by an agent is treated as supplemental wages. If the agent does not pay regular wages to the employee, the agent may choose to withhold income tax at a flat 27% rate, rather than at the wage withholding rate.

Third party not an agent.   Sick pay paid by a third party that is not your agent is not subject to mandatory income tax withholding. However, an employee may elect to have income tax withheld by submitting Form W-4S to the third party.

If Form W-4S has been submitted, the third party should withhold income tax on all payments of sick pay made 8 or more days after receiving the form. The third party may, at its option, withhold income tax before 8 days have passed.

The employee may request on Form W-4S to have a specific whole dollar amount withheld. However, if the requested withholding would reduce any net payment below $10, the third party should not withhold any income tax from that payment. The minimum amount of withholding that the employee can specify is $20 a week.

Withhold from all payments at the same rate. For example, if $25 is withheld from a regular full payment of $100, then $20 (25%) should be withheld from a partial payment of $80.

Amounts not subject to income tax withholding.   The following amounts, whether paid by you or a third party, are not wages subject to income tax withholding.

• Payments after the employee's death. 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 attributable to employee contributions. Payments, or parts of payments, attributable to employee contributions made to a sick pay plan with aftertax dollars are not subject to income tax withholding. For more information, see the corresponding discussion in Amounts not subject to social security, Medicare, or FUTA taxes earlier.

Depositing and Reporting

This section discusses who is liable for depositing social security, Medicare, FUTA, and withheld income taxes on sick pay. These taxes must be deposited under the same rules that apply to deposits of taxes on regular wage payments. See Circular E for information on the deposit rules.

This section also explains how sick pay should be reported on Forms W-2, W-3, 940 or 940-EZ, and 941.

Sick Pay Paid by Employer or Agent

If you or your agent (defined earlier) make sick pay payments, you deposit taxes and file Forms W-2, W-3, 940 or 940-EZ, and 941 under the same rules that apply to regular wage payments.

However, the agreement between the parties may require your agent to carry out responsibilities that would otherwise have been borne by you. In this situation, your agent should use its own name and EIN (rather than yours) for the responsibilities it has assumed.

Reporting sick pay on Form W-2.   You may either combine the sick pay with other wages and prepare a single Form W-2 for each employee, or you may 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 (see Box 12 below in the list of information that must be included on Form W-2). All Forms W-2 must be given to the employees by January 31.

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:

• 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).

Sick Pay Paid by Third Party

The rules for a third party that is not your agent depend on whether liability has been transferred as discussed under Third-Party Payers of Sick Pay earlier.

To figure the due dates and amounts of its deposits of employment taxes, a third party should combine:

1. The liability for the wages paid to its own employees and
2. The liability for payments it made to all employees of all its clients. This does not include liability transferred to the employer.

Liability not transferred to the employer.   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 (or 940-EZ) and 941. In this situation, the employer has no tax responsibilities for sick pay.

The third party must deposit social security, Medicare, FUTA, and withheld income taxes using its own name and EIN. 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 as shown in Reporting sick pay on Form W-2 earlier.

Liability transferred to the employer.   Generally, if a third party satisfies the requirements for transferring liability for the employer part of the social security and Medicare taxes and for the FUTA tax, the following rules apply.

Deposits.   The third party must make deposits of withheld employee social security and Medicare taxes and withheld income tax using its own name and EIN. You must make deposits of the employer part of the social security and Medicare taxes and the FUTA tax using your name and EIN. In applying the deposit rules, your liability for these taxes begins when you receive the third party's notice of sick pay payments.

Form 941.   The third party and you must each file Form 941. Line 9 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 you and the third party.

• Employer. You must include third-party sick pay onlines 2, 6a, and 7a of Form 941. (There are no entries for sick pay on lines 3 through 5.) After completing line 8, subtract on line 9 the employee social security and Medicare taxes withheld and deposited by the third party. Enter that amount in the Sick Pay space provided. If line 9 includes adjustments unrelated to sick pay, show those amounts in the spaces provided and the total in the line 9 entry space on the right.
• Third party. The third party must include on Form 941 the employee part of the social security and Medicare taxes (and income tax, if any) it withheld. The third party does not include on line 2 any sick pay paid as a third party but does include on line 3 any income tax withheld. On line 6a, the third party enters the total amount it paid subject to social security taxes. This amount includes both wages paid to its own employees and sick pay paid as a third party. The third party completes line 7a in a similar manner. On line 9, the third party subtracts the employer part of the social security and Medicare taxes that you must pay. The third party enters the amount you must pay on line 9 in the Sick Pay space provided. If line 9 includes adjustments unrelated to sick pay, the third party shows those amounts in the spaces provided and the total of all adjustments in the line 9 entry space.

Form 940 or 940-EZ.   You, not the third party, must prepare Form 940 or 940-EZ for sick pay.

Third-party sick pay recap Forms W-2 and W-3.   The third party must prepare a third-party sick pay recap Form W-2 and a third-party sick pay recap Form W-3. These forms, previously called dummy forms, do not reflect sick pay paid to individual employees, but instead show the combined amount of sick pay paid to all employees of all clients of the third party. The recap forms provide a means of reconciling the wages shown on the third party's Form 941. However, see Optional rule for Form W-2 later. Do not file the recap Form W-2 and W-3 electronically or on magnetic media.

The third party fills out the third-party sick pay recap Form W-2 as follows:

• Box b - Third party's EIN.
• Box c - Third party's name and address.
• Box e - Third-Party Sick Pay Recap in place of the employee's name.
• Box 1 - Total sick pay paid to all employees.
• 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 sick pay.
• Box 5 - Sick pay subject to employee Medicare tax.
• Box 6 - Employee Medicare tax withheld from the sick pay.

The third party attaches the third-party sick pay recap Form W-2 to a separate recap Form W-3, on which only boxes b, e, f, g, 1, 2, 3, 4, 5, 6, and 13 are completed. Enter Third-Party Sick Pay Recap in box 13. Only the employer makes an entry in box 14 of Form W-3.

Optional rule for Form W-2.   You and the third party may choose to enter into a legally binding agreement designating the third party to be your agent for purposes of preparing Forms W-2 reporting sick pay. The agreement must specify what part, if any, of the payments under the sick pay plan is excludable from the employees' gross incomes because it is attributable to their contributions to the plan. If you enter into an agreement, the third party prepares the actual Forms W-2, not the third-party sick pay recap Form W-2 as discussed earlier, for each employee who receives sick pay from the third party. If the optional rule is used:

1. The third party does not provide you with the sick pay statement described below and
2. You (not the third party) prepare third-party sick pay recap Forms W-2 and W-3. These recap forms are needed to reconcile the sick pay shown on your Form 941.

Sick pay statement.   The third party must furnish you 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:

• 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.

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