Everything You Need to Know About Third-Party Sick Pay

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What Is Third-Party Sick Pay Exactly?

There are many definitions out there, but we’d like to stick with this one because it is the least confusing. From a blog, third party sick pay is when the company continues to pay the employee in case they’re sick/ill and they cannot work.

Third-party sick pay is taxable when it is paid by the employer, however, if the employee pays for it, it is not taxable, according to the publication by the IRS. Many employers provide this facility to their employees, and paid sick leaves along with absences from work.

Let’s say you get a fever. The doctor recommends you to take three days off from work to rest. You can inform your company and they will assign you third-party sick pay. However, there’s an important thing that needs to be mentioned here.

Your sick pay will depend on the amount of paid leaves that you have left. Let’s say your sickness goes beyond what your doctor originally thought but you’ve already used up your sick time, your employer may have no option but to stop paying you. They may not lay you off from the job, but they may stop paying you. This is known as unpaid leave. As the name implies, employees are not paid for their leaves.


Third-party sick pays are primarily issued by Third-Party Administrators (TPAs) and these are your regular insurance companies. In place of the wages that you have lost, they issue sick pay. However, some companies also offer these services to their employees internally. This obviously costs more.

Disability Benefit

Another thing to note here is that third-party sick pay is not restricted to flues or sickness. They also apply when an employee has become disabled recently. This disability may or may not be due to an injury that has resulted from work.

How Does it Function?

Now that we’ve explained what third-party sick pays are, it is important to explain how they exactly work. These payments mimic regular paychecks that the employee receives from their employer. One difference is that they do not receive the full payment that they would receive otherwise. Only a percentage is received. Second, the insurance company issues the checks, not the company itself. If you want to read the regulations about third-party sick pays, i think this one my do you some favors.

Even though both the employer and the employee have to stay active during the payment procedure, it is the job of the employer of the employee to closely monitor these payments and transactions, not the employee.

It is right to say that third-party sick pay is earned income. It cannot be classified as unearned income because it is received during the first six months of the accident/illness. In case the employee wishes to receive it after six months have passed, then yes, it is right to classify it as unearned income.

What’s Not Considered Third-Party Sick Pay?

It is easy to confuse other types of payments and incomes as third-party sick pay. First of all, no type of disability retirement payments are considered third-party sick pays. Second, medical expense payments are separate from third-party sick pays. Third, workers’ compensation doesn’t come under third-party sick pay as well.

Why does this matter? Primarily because of tax reasons. Another is that they have to be reported differently if they’re not third-party sick pays.

Crafting a Third-Party Sick Plan

Let’s say you’re interested in making your own third-party sick plan. Indeed, it is necessary to have one in case there’s an unfortunate incident that happens to you in the future. The first step is to create a plan. Your plan should tell who qualifies for the sick pay and the contributions that you have made.

Different types of information need to be provided if you’re going to make a third-party sick plan. First, the employee’s total wages that they will receive during the whole year. Second, any information that will be required in identifying the employee (including their name). Next, when did the employee last work for the employer? Finally, the amount of after-tax money that the employee has given for the sick plan.

When all of this is done, there’s not much left. You just have to make contributions to the third party.

When third-party sick payments are done, they need to be properly recorded. So there is care and attention paid before, during, and after the payments are done. These payments and their notices need to be properly documented.

How Do You Report Third-Party Sick Pay to the IRS?

Sick pay can either be short-term or long-term. They can be paid by the employer themselves or third-party agencies (such as insurance companies) and, here, an employee’s agent will be involved. Regardless of these factors and scenarios, the Social Security and Medicare (FICA) taxes need to be paid on the payments that have been received by the employee. There are circumstances and special rules whereby the employer and the third-party can distribute the liability among each other that includes the withholding, depositing, and reporting of the taxes that are involved. These taxes are attributed to sick pay, by the way.


In a situation when the employer’s sick pay plan has been self-insured, the employer will be required to hold the risk of insurance and they will make the payments. However, when the employer makes a contract with a third party to create a sick pay plan, then the employer will possess the responsibility for tax withholding. When the payments are made by a third party, but they are not agents, then the third party will be given the risk and they will be liable for the income tax withholding.

Third-party sick pay is really helpful for employees out there. Especially during COVID times, situations are very unstable. Employees are getting sick day in and out, and it is especially important for them in these trying times to have a sick plan. They might not receive their full salary but something is better than nothing. This way, even while they’re not working they can stay a part of the company. On top of that, they can receive payments as well.


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