Health issues can strike unexpectedly, and when you’re unable to work due to illness or injury, it can be a financial strain. This is where sick pay, including third-party sick pay, can come to the rescue. However, the tax implications of such payments can be confusing. This is why you have to be careful while preparing for the end year and beginning about third-party sick pay reporting for compliance with the laws.

In this blog, we’ll explore the latest tax treatment of third-party sick pay in Pennsylvania and help you understand your tax obligations.

Understanding Third-Party Sick Pay

Before delving into the tax aspects, let’s clarify what third-party sick pay is. The money you get from your insurance provider or another third party when you are unable to work because of a sickness or accident is known as third-party sick pay.  Payments from workers’ compensation, long-term disability insurance, short-term disability insurance, and personal injury settlements might all fall under this category.

The premiums for this kind of coverage, which is frequently included in employment benefits packages, may be covered by your employer, you, or a combination of the two. So, you may ask if sick pay is taxable or not if paid by a third party.

Is Third Party Taxable in Pennsylvania?

Third-party sick pay is not taxable in Pennsylvania. This means that payment you receive from a third-party insurer, such as short-term disability insurance, is not considered taxable income since it is not a regular source of income.

You are, however, taxed on your sick pay in Pennsylvania if your employer pays it directly to you. This is due to the fact that Pennsylvania income tax must be deducted by your employer from your regular salary.

How Third-Party Sick Pay is Different From Regular Sick Pay?

Third-party sick pay	Regular sick pay
An employee who receives sick pay from a third party—such as an insurance provider or a government agency—is said to be receiving third-party sick pay. Unlike regular sick pay, it is not paid directly by the employer to the employee.	An employee’s company may offer them regular sick pay as a form of paid time off to help them heal from a sickness or accident. Usually, the employer pays for it, and the employee is paid at their regular rate.
Examples of third-party sick pay: • Short-term disability insurance • Long-term disability insurance • Workers’ compensation • Personal injury settlements • State-mandated paid sick leave programs	Examples of regular sick pay: • Paid time off (PTO) • Sick leave vacation pay

Differences between third-party sick pay and regular sick pay:

• Payor: A third-party sick pay payor is an insurance company or government agency that pays sick pay. Regular sick pay is paid by the employee’s employer.
  
  
• Funding: Third-party sick pay may be provided by the employee, the employer, or both. Regular sick pay is typically funded by the employer.
  
  
• Taxability: Third-party sick pay is generally not taxable income for the employee. Regular sick pay is generally taxable income for the employee.

What are some exceptions to Third Party Sick Pay Tax?

Third-party sick pay is typically not considered taxable income in Pennsylvania. Even if the payments are given in lieu of your normal income. However, there are a few exceptions to this rule:

1. Funding employers: An organization that provides whole or partial funding—directly or indirectly—for a third-party payor to pay one or more of its employees’ sick leave is known as a funding employer. The Pennsylvania Unemployment Compensation Fund requires funding employers to report and pay contributions based on the amount of third-party sick pay they finance.

2. Employees who receive third-party sick pay in lieu of regular wages: Employees who receive third-party sick pay payments in lieu of regular wages may be required to pay Pennsylvania income tax on the payments. This is because the payments are essentially a substitute for regular wages.
   
   For example, if an employee is out of work due to an illness and receives short-term disability payments from their insurance company, these payments may be considered third-party sick pay instead of regular wages. If so, the employee may be required to pay Pennsylvania income tax on the payments.
   
   However, there are some exceptions to this rule. For example, if the employee is receiving third-party sick pay payments under a state-mandated paid sick leave program, these payments may not be considered third-party sick pay in lieu of regular wages. In this case, the employee would not be required to pay Pennsylvania income tax on the payments.

3. Employees who are double-dipping: It may be necessary for employees to pay Pennsylvania income tax on third-party sick pay payments if they also get other benefits like workers’ compensation or unemployment benefits. This is to stop employees from getting benefits that exceed what they would have received from working.

If you are unsure whether or not your third-party sick pay payments are taxable in Pennsylvania, you should consult with a qualified tax professional.

Which type of sick pay is better?

Whether third-party sick pay or regular sick pay is better for an employee depends on their individual circumstances. If an employee has a pre-existing medical condition or is at risk of developing a medical condition that could prevent them from working, third-party sick pay may be a better option. For employees with a predictable work schedule and no major health concerns, regular sick pay may be the best option.

Employees should carefully consider their individual circumstances and needs when deciding which type of sick pay is best for them.

What If You Are Taxed for Third Party Sick Pay?

In the event that you receive third-party sick pay, and your employer includes it on your W-2 Form for tax filing, you should contact your employer and request a corrected W-2 Form. If you believe that the error was caused by your employer, you can also submit a letter explaining the error to the Pennsylvania Department of Revenue.

To correct third-party sick pay on your Pennsylvania tax return if it was filled by your employer by mistake, you should:

1. Contact your employer and request a corrected W-2 Form.
2. File a Pennsylvania amended tax return (Form PA-40X).
3. Attach a copy of the corrected W-2 Form to the amended return.
4. Explain the error on the amended return.
5. You can file an amended tax return electronically or by mail. If you are filing electronically, you can use the Pennsylvania e-file system. If you are filing by mail, you can download Form PA-40X from the Pennsylvania Department of Revenue website.

Here are some additional tips for correcting third-party sick pay on your Pennsylvania tax return:

1. Be sure to file the amended return as soon as possible. If you owe additional tax, you may be subject to interest and penalties.

2. If you have any questions about how to file an amended return, you can contact the Pennsylvania Department of Revenue.

Here is an example of how to correct third-party sick pay on your Pennsylvania tax return:

Suppose you received short-term disability payments from your insurance company while you were out of work due to an illness. The payments were equal to your regular wages. However, your employer mistakenly included the short-term disability payments in your W-2 Form.

To correct the error, you would need to contact your employer and request a corrected W-2 Form. Once you have received the corrected W-2 Form, you will need to file a Pennsylvania amended tax return (Form PA-40X). You would attach a copy of the corrected W-2 Form to the amended return and explain the error.

If you are owed a refund, the Pennsylvania Department of Revenue will send you a refund check. If you owe additional tax, you will need to pay the tax, interest, and any penalties that may apply.

Key Takeaway:

Understanding the tax implications of third-party sick pay can help you manage your finances effectively during challenging times. If you have specific questions or concerns regarding your situation, it’s always a good idea to consult with a tax professional or refer to the latest guidance from the Pennsylvania Department of Revenue for the most accurate and up-to-date information.