Paid Sick and Family Leave: The Tax Rules
As of this writing, 15 states and Washington, D.C., require paid sick leave, while eight states and Washington, D.C., require paid family leave. Many local governments also mandate paid sick or family leave.
In addition, studies show that most employers offer paid sick leave, even if not legally required to — and employers are increasingly choosing to provide paid family leave.
So it's crucial that employers understand their tax-withholding responsibilities when it comes to paid sick and family leave.
Tax withholding for paid sick leave
If you voluntarily offer paid sick leave and make the payments directly to employees — via your payroll system or your payroll provider — then sick leave wages are generally taxable for federal, state and local purposes. The payments are usually taxed similarly to regular wages — meaning federal income tax, Social Security tax, Medicare tax, and applicable state and local taxes should be withheld.
However, accumulated sick leave payments should be treated as supplemental wages, as defined by the Internal Revenue Service.
Third-party sick leave payments
Things are a little more complicated when sick leave payments are made by a third party, such as an insurance company.
Generally, if sick leave payments are made by a third party that is not an agent of the employer, then withholding taxes is voluntary — meaning the employer is not automatically required to withhold taxes. The employee can, however, ask the employer to withhold federal income tax by submitting IRS Form W-4S.
In general, though, the third-party payer is responsible for withholding applicable federal, state and local taxes.
Note that sick leave payments are subject to Social Security and Medicare taxes only for the first six months after the sick leave began. Though the payments are exempt from Social Security and Medicare taxes after six months, they remain subject to federal income tax.
Mandatory paid sick leave
Paid sick leave required by the state or local government is typically considered "wages" from which applicable employment taxes should be withheld. Employers may contact their state or local revenue agency for tax-withholding guidelines. Employees' contributions to a state-mandated paid family leave program are after-tax deductions, meaning applicable taxes must be withheld from the contributions.
As you see, the paid benefits universe is complex, and there are issues beyond what were discussed here. So your best bet is to work closely with a financial professional who can help you make sure your benefits are in compliance with tax and withholding rules.