If you work in HR, payroll, or compliance, there’s a good chance you’ve dealt with third-party sick pay before, whether it’s figuring out how to report it on a W-2, or answering confused employees during tax season. But here’s a question that comes up often and catches a lot of teams off guard:
Is third-party sick pay taxable in New Jersey? Like most tax questions in this state, the answer isn’t cut and dry, and yet, for professionals responsible for getting payroll right, it’s essential to understand. Misreporting even a small detail here can trigger headaches down the road for both employers and employees.
Let’s break it down clearly, based on how New Jersey treats this issue, not just federally, and explain why this matters to the roles you and your team perform.
What Is Third-Party Sick Pay?
Third-party sick pay is income paid to an employee by a separate entity (typically an insurance provider) when they’re out of work due to non-job-related illness or injury. The payments usually come through short-term or long-term disability insurance policies.
In other words, the employee isn’t working, but they’re still receiving income, and the taxability of that income, especially at the state level, is where things get nuanced.
So, Is It Taxable in New Jersey?
Short answer: It depends on who paid the premiums. Here’s how it works under New Jersey Gross Income Tax rules:
- If the employer pays the premiums (even partially), the third-party sick pay is generally considered taxable income in New Jersey.
- If the employee pays 100% of the premiums with after-tax dollars, the benefits received are typically not taxable by the state.
It’s also important to distinguish between wages vs. non-wages for reporting purposes. If the payments are treated as wages, they may be subject to withholding and reporting requirements, including on the W-2.
Pro Tip for Payroll Teams: Many employers outsource disability insurance and assume it’s out of their hands. But unless the insurer handles full W-2 reporting and tax withholding (and even then), your team is still responsible for accurate classification and coordination.
Why This Matters for HR, Payroll, and Compliance Teams
Here’s where it gets serious for professionals in your department:
- Incorrect taxability assumptions can result in incorrect withholding, or worse, issuing faulty W-2s.
- Overreporting can lead to frustrated employees who overpay taxes.
- Underreporting creates audit risks and penalties.
- Miscommunication with third-party insurers can leave gaps in third party sick pay reporting or missed deadlines.
This is especially critical if you:
- Process year-end tax forms
- Handle disability benefits coordination
- Respond to employee questions about benefit taxation
- Are responsible for regulatory compliance in multi-state operations
Even if you’re using trusted payroll software, don’t rely on automation alone. Software can’t always account for New Jersey’s quirks unless you feed it the correct data, like who paid the premiums, and whether they were pretax or post-tax.
You can read more about the difference between the Benefits Of Third-party Sick Pay Vs Short-term Disability.
What You Should Do to Handle Third-Party Sick Pay Correctly
If you’re responsible for payroll, HR, or compliance, here’s how to make sure third-party sick pay is handled the right way, without confusion or costly mistakes:
1. Confirm Who Paid the Premiums
Start with the key detail: who funded the disability insurance policy?
- If the employer paid all or part of the premiums, the sick pay is likely taxable in New Jersey.
- If the employee paid 100% with after-tax dollars, the benefits are usually non-taxable.
If the cost was shared, you’ll need to determine what portion of the benefit is taxable, it’s not always an all-or-nothing situation.
2. Coordinate with Your Third-Party Provider
Don’t assume the insurer is handling everything.
- Clarify who’s responsible for tax withholding and who will issue the W-2 (if required).
- Make sure any reporting from the provider aligns with your internal records.
Good communication here avoids duplicate reporting, or worse, missing information entirely.
3. Review W-2 Forms with a Sharp Eye
Before year-end, take a close look at affected employees’ W-2s:
- Box 1 should reflect taxable wages (including any taxable sick pay).
- Box 12 may include code J or other indicators of sick pay.
- Box 14 can be used for informational reporting, depending on your setup.
Make sure the numbers match up with what’s actually taxable based on who paid the premiums.
4. Educate Your Internal Team and Employees
Don’t underestimate how confusing this topic is for employees, and even for new HR or payroll staff.
- Provide clear guidance internally so your team understands how sick pay is taxed and reported.
- Communicate with employees who receive these benefits so they know what to expect on their W-2s and why.
A little proactive clarity saves everyone time and avoids frustration during tax season.
You can read more about taxability of third party sick pay in Pennsylvania.
Final Thoughts
For HR, payroll, and compliance professionals, this isn’t just a tax trivia question, it’s a compliance responsibility.
In New Jersey, third-party sick pay can be taxable or not, depending on how the insurance was funded. And while the state’s rules largely echo federal treatment, don’t assume they’re identical.
If you’re in charge of payroll compliance or benefits administration, this is one of those “small but mighty” details that can trip up year-end reporting if not handled correctly.Make sure your internal processes, and your vendors, are aligned with the specifics of New Jersey law. Because in tax compliance, especially in a state like NJ, the fine print isn’t just annoying. It’s essential.
If you want to future-proof your career, the path is clear: use high-quality resources to grow your knowledge (start with Compliance Prime’s expert Payroll Compliance Webinars, and apply smart, tactical actions that show you’re not just keeping up, you’re stepping ahead.
