Third-Party Sick Pay Reporting: Year-End Requirements
6/19/2026
Third-party sick pay is a small topic that causes a disproportionate share of year-end reconciliation failures, for one reason: reporting responsibility depends on a contractual relationship that payroll frequently does not know the terms of.
Two outcomes recur. Both the employer and the insurer report the same wages, doubling the employee's reported income. Or neither reports, leaving wages off both the Forms W-2 and the Forms 941. Either way the variance surfaces in January, when the answer requires a conversation with a third party who is also closing their year.
What Third-Party Sick Pay Is
Payments made to an employee by a third party — typically an insurance company or a third-party administrator — for a period during which the employee is absent from work due to sickness or disability.
It is distinguishable from:
- Employer-paid sick leave, which is ordinary wages paid by the employer
- Workers' compensation benefits, which are generally not taxable and not reported as wages
- Long-term disability paid entirely by the employee's after-tax premiums, which is generally not taxable at all
The tax treatment turns on who paid the premiums:
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Premium funding
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Benefit taxability
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Employer-paid premiums
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Benefits are taxable
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Employee after-tax premiums
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Benefits are generally not taxable
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Employee pre-tax premiums through a cafeteria plan
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Benefits are taxable
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Split funding
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Proportionally taxable
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That third row surprises people. Paying premiums pre-tax through a cafeteria plan makes the benefits taxable — the exclusion depends on the premiums having been paid with after-tax dollars. So a well-intentioned decision to run disability premiums through the cafeteria plan changes the tax character of any benefit later received.
Agent vs. Non-Agent: The Determining Question
Reporting responsibility depends on whether the third party is acting as the employer's agent.
Agent status generally exists where the third party's liability is limited — it pays benefits from employer funds or is reimbursed, effectively administering rather than insuring. The third party is performing a service for the employer.
Non-agent status generally exists where the third party bears the insurance risk under an insurance contract.
The distinction is contractual, and it is why payroll must obtain the arrangement's terms rather than infer them. An arrangement described as "insurance" may be administratively self-funded, and vice versa.
Where the Agent Arrangement Lands
When the third party is an agent, the parties may generally allocate reporting responsibility by agreement:
- The third party may report the sick pay on its own Form W-2 under its own EIN, or
- The employer may report it on the employee's Form W-2, with the third party providing the necessary information
Either allocation works, provided both parties understand which applies. The failure is not choosing one.
Where the Non-Agent Arrangement Lands
When the third party is not an agent, responsibility is generally divided:
- The third party reports the sick pay wages and the taxes it withheld, generally on its own Form W-2
- The employer may still have obligations regarding its share of FICA
- Form 8922 exists specifically to reconcile the split, filed by whichever party did not report the wages on the Form W-2
Form 8922 is the piece most often missed entirely, because it does not arise in any other context and nobody encounters it until they need it.
The Six-Month FICA Rule
A rule worth memorizing, because it changes the answer partway through a long disability:
Sick pay is subject to Social Security and Medicare only for the first six calendar months after the last calendar month in which the employee worked. After that period, the payments are no longer wages for FICA purposes — though they generally remain subject to income tax where the premiums were employer-paid.
Practical consequences:
- A long-term disability case crosses this boundary, and the withholding must change
- The clock runs from the last calendar month worked, not from the date benefits began
- Payments in a subsequent year for a disability that began earlier are frequently past the six-month mark entirely
- Getting this wrong in either direction produces a FICA variance that will not reconcile
Income Tax Withholding on Sick Pay
Whether income tax is withheld depends on the arrangement:
Where the employer or its agent pays, sick pay is treated as wages and income tax withholding generally applies as it would to ordinary wages.
Where a non-agent third party pays, withholding is generally not automatic. The employee may request withholding by furnishing Form W-4S to the payer. Absent that request, no income tax is withheld — which means a long-term disability recipient may have no withholding at all and a substantial balance due at filing.
That is worth communicating to employees going on disability. It is not payroll's obligation to withhold in that arrangement, but the employee's surprise in April is avoidable with one sentence in the leave packet.
Year-End Reporting Mechanics
On the Form W-2, sick pay wages are included in the wage boxes by whichever party reports them, and the third-party sick pay checkbox in Box 13 must be checked on the form reporting it. That checkbox is frequently omitted.
Box 12 carries a code for nontaxable sick pay, used where the employee paid the premiums with after-tax dollars.
On the Form 941, the reporting party includes the wages and taxes, and there are specific lines and adjustments for the sick pay allocation between parties.
Form 8922 reconciles the split in non-agent arrangements, and is filed by the party that did not report the wages on the Form W-2.
Our Payroll Reporting Training & Certification Program covers information return reporting, and Payroll Year End: W-2 And Proper Year End Reconciliation covers the year-end process.
The Reconciliation Trap
This is where the topic actually costs employers money.
Third-party sick pay is one of the six standard causes of a Form W-2 to Form 941 variance. The mechanism:
- An employee goes on disability in, say, March
- The insurer begins paying benefits and withholding FICA
- Nobody establishes which party is reporting
- In January, both parties report the same wages — or neither does
- The variance appears in the year-end tie-out, and resolving it requires the insurer's cooperation during their own busiest period
The fix is a conversation in October, not January. Obtain from the third party, in writing: the total sick pay paid, the FICA withheld, the income tax withheld if any, the date the employee last worked, and a statement of which party is reporting the wages.
Our year-end reconciliation guide covers the tie-out, and Payroll Reconciliation And Reporting covers the method.
Adjacent Payroll Considerations
Benefit deductions during disability. Health premiums and other deductions continue to be owed, but there may be no wages from the employer to deduct from. This requires a pre-pay, pay-as-you-go, or documented catch-up arrangement — see our cafeteria plans guide.
Retirement plan treatment. Whether sick pay counts as plan compensation, and whether deferrals continue, is governed by the plan document.
FMLA and leave coordination. Disability leave frequently runs concurrently with FMLA and may interact with state paid leave programs. See our Leave Management Compliance Suite.
State treatment. State income tax and state disability program treatment can differ from the federal analysis and must be confirmed separately.
What to Ask the Third Party, and When
Because everything in this topic depends on information payroll does not hold, the practical skill is knowing exactly what to request. Send this in October, not January.
Request in writing:
- Is the arrangement agent or non-agent? Ask directly rather than inferring from how the product is described. If the answer is agent, ask which party will report the wages on the Form W-2.
- Total sick pay paid per employee for the year to date, with an estimate through year end.
- Social Security and Medicare withheld per employee, and the employer share the third party paid or expects to be reimbursed for.
- Federal income tax withheld, if any, and whether the employee filed a Form W-4S.
- Each employee's last calendar month worked, as the third party understands it, so the six-month FICA clock can be verified against your own records.
- State income tax withheld, by state.
- Which party will file Form 8922, where a non-agent split applies.
- The premium funding split — employer-paid, employee after-tax, or employee pre-tax through a cafeteria plan — since this determines taxability.
Why October. Two reasons. First, the third party is also closing their year in January and is least responsive precisely when you need them most. Second, if the answer reveals a problem — FICA continuing past the six-month mark, or an assumption that you were reporting when you assumed they were — October leaves time to fix the current-year treatment rather than only to correct it afterward.
Reconcile what you receive. Do not simply adopt the third party's figures. Compare their last-month-worked dates against your own termination and leave records, and verify the six-month FICA cutoff independently. Vendor calculations are frequently right and occasionally not, and the reporting obligation is yours regardless.
A Checklist
- [ ] Obtain the contract terms and determine agent vs. non-agent status
- [ ] Confirm in writing which party reports the wages on the Form W-2
- [ ] Determine premium funding — employer, employee after-tax, or pre-tax through a cafeteria plan
- [ ] Identify each affected employee's last calendar month worked for the six-month FICA clock
- [ ] Confirm FICA stopped after the six-month period where applicable
- [ ] Obtain total sick pay, FICA withheld, and income tax withheld from the third party in October
- [ ] Check the third-party sick pay box on the reporting Form W-2
- [ ] Use the Box 12 nontaxable sick pay code where premiums were employee after-tax
- [ ] File Form 8922 where a non-agent split requires it
- [ ] Include the amounts in the year-end reconciliation before filing
- [ ] Communicate to employees going on disability that a non-agent payer generally will not withhold income tax unless they file Form W-4S
Frequently Asked Questions
Is third-party sick pay taxable?
It depends on who paid the premiums. Benefits are taxable where the employer paid the premiums, and also where the employee paid them pre-tax through a cafeteria plan. Benefits are generally not taxable where the employee paid the premiums with after-tax dollars. Split funding produces proportional taxability. The pre-tax cafeteria plan result surprises many employers.
Who reports third-party sick pay on a W-2?
It depends on whether the third party is acting as the employer's agent. In an agent arrangement — where the third party's liability is limited and it administers rather than insures — the parties may allocate reporting by agreement to either the third party or the employer. In a non-agent arrangement, the third party generally reports the wages and taxes it withheld, and Form 8922 reconciles the split.
What is the six-month rule for sick pay?
Sick pay is subject to Social Security and Medicare only for the first six calendar months after the last calendar month in which the employee worked. After that, payments are no longer FICA wages, though they generally remain subject to income tax where the premiums were employer-paid. The clock runs from the last month worked rather than from when benefits began, which matters for long-term disability cases and for payments continuing into a later year.
Is income tax withheld from third-party sick pay?
Where the employer or its agent pays, income tax withholding generally applies as with ordinary wages. Where a non-agent third party pays, withholding is not automatic — the employee must request it by furnishing Form W-4S to the payer. Absent that request, a long-term disability recipient may have no withholding at all and a substantial balance due at filing, which is worth mentioning in the leave packet.
What is Form 8922?
The return that reconciles third-party sick pay reporting in a non-agent arrangement, filed by whichever party did not report the wages on the Form W-2. It exists solely for this purpose, which is why most payroll professionals never encounter it until a sick pay arrangement requires it.
Why does third-party sick pay cause W-2 reconciliation problems?
Because reporting responsibility depends on a contractual relationship payroll often does not know the terms of. The typical sequence is that an employee goes on disability, the insurer begins paying and withholding, nobody establishes which party reports, and in January either both parties report the same wages or neither does. Resolving it then requires the insurer's cooperation during their own year-end. The fix is obtaining the figures and the reporting allocation in writing in October.
Going Deeper
Third-party sick pay reporting depends on contract terms and on the specific arrangement. Obtain the agreement's provisions and confirm the reporting allocation with the third party in writing well before year end.
