May 2, 2022
Minnesota updates guidance on withholding state income tax from third-party sick payments
The Minnesota Department of Revenue has updated its guidance on the state income tax withholding and reporting requirements for disability payments made by a third-party insurance provider (third-party sick pay). Third-party sick pay includes amounts employees receive for absences due to injury, sickness or disability and includes benefits for both short-term and long-term disability that are generally a percentage of the employee's regular wages.
The Department explains that whether state income tax withholding is required from third-party sick payments depends on who paid for the disability insurance.
If employees pay the disability insurance premium, the disability payments are not subject to Minnesota income tax or income tax withholding and the payments are not reported on a Form W-2 or Form 1099. This is true whether employees purchase the disability insurance independently or pay the cost of insurance provided by the employer.
State income tax withholding is required if the employer makes disability payments directly to the employee through a self-insured plan or the benefits are paid by a third-party insurance company. In the case of a self-insured plan, the employer is responsible for withholding the state income tax and for reporting the payments on Form W-2.
When payments are made by a third-party income provider, the third party is responsible for withholding the state income tax and for reporting the payments on Form W-2. Whether the federal employer identification number of the third-party or the employer is used on the Form W-2 depends on the contractual agreement between the employer and the third party.
As explained in the Department's Withholding Fact Sheet 9, Minnesota follows the federal rules governing the income tax treatment of third-party sick pay. For more information concerning the federal taxation and reporting of third-party sick pay, see IRS Publication-15-A.
Ernst & Young LLP insights
Under federal law, income tax and withholding applies only to the extent the employer pays for the disability insurance premium. For example, if the employer pays 40% of the disability insurance, 40% of the third-party sick pay is subject to federal income tax and withholding.
Overview of federal income tax treatment of third-party sick pay (see Publication 15-A)
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