Short-term disability coverage pays all or a portion of an employee’s wages for non-occupational illness, injury, and pregnancy-related disability for six months or less. These benefits may be fully or partially taxable for social security, Medicare, FUTA, SUI, federal, state, and local withholding depending on who makes the payment. If the employer or the employer’s agent makes the payment, the amounts are subject to federal and state withholding. If the payment is made by a third party (see “Third Party Sick Pay”), income tax withholding is generally optional.
Long-term disability coverage pays all or a portion of an employee’s wages for non-occupational illness, injury, and pregnancy-related disability paid for longer than six months after the last calendar month in which the employee worked. These benefits are exempt from social security, Medicare, and FUTA, but may still be fully or partially taxable for SUI, federal, state, and local withholding under the same provisions as described for short-term disability.
Employers and/or employees can make contributions to the premiums for short- and long-term disability. The amount the employee pays determines the taxability. Some disability is state-provided, and the taxability may differ from private providers.
When the employer’s insurance company or agency, not the employer, pays short- and long-term disability other than as the employer’s agent, the payment constitutes third party sick pay. A third party is acting as the employer’s agent if it has no insurance risk, such as where it is compensated on a cost-plus-fee basis. The third party payer must withhold FICA on the taxable portion of the payment, but other taxes are only withheld at the employee’s request. Either the employer or the third party payer may report disability payments to the government on Form W-2.
Employers usually pay for disability coverage, but some require their employees to contribute toward premium costs or purchase additional coverage. In CA, NJ, NY, HI, and RI, state plans allow for a disability premium deduction from employees’ wages. Benefits are taxable in the same ratio that the employer pays the premium. State laws vary and may mandate a certain level of coverage.
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