3rd Party Sick/Disability Pay

[Guest Chris API]

Hi all,

I have been trying to research the answer to this question for some time, but have run into a wall it seems. Here's the scenario:

Plan has W-2 compensation as definition of comp

Company offers sick/disability insurance

Employees take leave (maternity, etc.) and receive benefits from insurance

Insurer/employee(s) have requested that the company report the benefits and tax withholdings so they can include them on W-2 for the employee

Insurer pays the employee for the benefits, the company has no control over payments

So the questions are, since the benefits are included on the W-2, and W-2 comp is the definition in the plan, how do the participants defer on this kind of compensation? Is this not ineligible compensation to defer on since the company can't withhold deferrals?

If it is included as compensation, this will affect the deferral %, which could potentially affect the matching contribution.

I'd love you all's responses. Thanks in advance for the help. I'm a short time reader on the board, and this is my first post.

[Guest Chris API]

wow, guess this issue is more difficult than I thought with the no responses. I'll have to admit, this issue has stumped me as well.

[Brenda Wren]

Most disability plans are paid 100% by the employee with after-tax dollars. Even if the employer wants to pay part of the premium, it is usually bonused to the employee so that the employee can pay the premiums with after-tax monies and enjoy tax-free benefits if a claim is made in the future. If that's the case, the benefits are "reportable" on W-2, but not "taxable". The benefits do not flow through to Box 1, 3 or 5. Rather they are reported in Box 12a with a code J. Since the benefits are not taxable and not subject to FIT or FICA, they should not be included for any plan purpose either.

If the disability plan is being paid with pre-tax dollars, I don't know the answer.

[K2retire]

I was always told that if the benefit is paid by the employer it is included and if it is paid by an insurance company it is not.

[austin3515]

Since most plan's use W-2 as the defintion of wages, ST disability (sometimes called TP Sick Pay) is included in the plan's definition of compensation (i.e., because the STD is reported on the w-2. Because it is no different than a normal sick day, it would not be a fringe benefit, and therefore would have to be speciically excluded.

No word on how 401k works on that, but if shomeome for example is SH Eligible, the amounts should be included.

[Bird]

This is one of those all-too-frequent things where I had the answer and don't quite remember and can't find the notes on it. I know I've posted before, with some certainty, whether that was an "often wrong but never in doubt" moment I'm not sure.

I'm going to go out on a limb and say you do not count it; I think it's added back to the W-2 as a reporting convenience more than anything else. Using "W-2 compensation" as the definition of compensation doesn't necessarily mean you're going to find the right number on the W-2.

[movedon]

I recall treating the payments as plan comp if they are reported on the W-2 and the insurance premiums were paid by the employer, but like others here, I can't really remember my authority for that and can't be arsed to look. Check the EOB.

[austin3515]

While perhaps Bird's interpretation is just as (if not more reliable than mine, I would contend the 3rd party sick pay is usually so small, and 3% of that number is therefore VERY small, the best course of action would generally be to include it.

In favor of my argument though, I do find it sort of hard to justify NOT using W-2 wages, if that is the plan's definition of compensation. In toher words, using an insurance company to provide sick pay shouldn't be a back door to avoiding a safe harbor contribution (as an example).

[Belgarath]

I'm with Austin on this one. If the benefit is paid by the employer, or is paid through insurance where the premiums are paid by the employer, then it's appropriate W-2 income. (Although when I looked into this way back when, I never considered whether it would count as "earned income" for an unincorporated owner, and I'm not going to look it up until it happens!!)

I think it's pretty clear that it is generally counted for 415 purposes. See 1.415©-2(b)(3), which also refers you to IRC 104. And note that 104(a)(3) INCLUDES disability pay from insurance IF the premiums are paid by the employer. And as Austin says, if the plan defines compensation for accrual/allocation purposes as W-2, given the above, how can you exclude it?

I have no idea how you would handle the actual mechanics of a deferral in this situation. That's a tough one! The only situation I saw, the participant stopped making deferrals once disabled, and this item only came up for purposes of a 3% nonelective safe harbor contribution.

[Guest Chris API]

thanks to everyone for your responses!

[VTPension]

So it has been months since the first post on this topic and you've all probably lost interest in it. But I am now faced with the issue. All the comments make some manner of sense but what about the fact that the employer is getting the deduction for the premiums? Should he/she be able to deduct a pension allocation against wages he didn't pay? Think of a plan that is stuffed up to the 25% limit - should that 3rd party pay really be included? And, if the insurer had reported the income it would not be an issue at all, but just because it was reported by the emplouer even though not paid by the employer it is? I could go either way on it. If a client points on 3rd party sick pay, I'd probably back it out. If it was there and I didn''t know it, I probably wouldn't care. So now I wonder if we should be asking for it to be broken out in our annual data requests.