Learn how to track and submit taxable third-party sick pay.

Third-Party Sick Pay is payment that an employee receives from a third party, other than their employer, such as insurance providers or trusts. These payments are also known as short-term disability payments.

How you enter the taxable third party sick pay in QuickBooks Desktop depends on who will submit the tax payments for employee paid taxes (such as Medicare and Public Pension employee portion) and who will file the tax form.

We show you how to track, report and create paychecks related to Third-Party Sick Pay in QuickBooks Desktop Payroll for Basic, Standard and Enhanced.

A note about taxes

  • To allow the taxes to be withheld from actual wages paid to the employee, taxable third-party sick pay should be included with a regular paycheck whenever possible. If this is not possible (for example, if the employee has not yet returned to work or the sick pay crosses over to another calendar year), then an "employee advance" may be necessary to cover the taxes.
  • If the employee portion of Public Pension, Medicare and or federal withholding has been paid by a third-party, also follow the additional steps at the end of this article.

Step 1: Create an Expense Account

First thing you need to do is create an Expense Account. This is to track Third Party Sick Pay in your Chart of Accounts.

  1. Select the Lists drop-down, choose Chart of Accounts.
  2. Select Account, and New.
  3. Select Expense and Continue.
  4. Enter the name of the new Expense account (something like, Taxable Third Party Sick Pay) in the Account Name field. Note: We recommend that you create this Expense account as a sub-account of "Payroll Expenses" to make the new account easier to find and to associate it with payroll expenses. To do this, check the Subaccount of box and select Payroll Expenses from the drop-down list.
  5. Select Save & Close.

Step 2: Create an Addition payroll item.

Next, create an Addition payroll item. You'll need this item if you are reporting Third Party Sick Pay on employee's W-2.

  1. Select Lists, and choose Payroll Item List from the drop-down.
  2. Select Payroll Item and then select New.
  3. Select Custom Setup, and Next.
  4. Select Addition, and Next.
  5. Enter the name of the new payroll Addition item (e.g., "Add Taxable Third Party Sick") in the Enter name for addition field, and Next.
  6. Select the name of the Expense account from the Enter the account for tracking this expense drop-down list, created in step 1, and Next.
  7. Select Compensation from the drop-down list, and then Next. (The paid amount will appear in box 1 of the W-2 form).
  8. Select the Federal and State taxes that apply. If sick pay is provided through a third party, such as an insurance company, income tax withholding does not apply unless requested by the employee.
  9. Select Next.
  10. Select Neither, and Next.
  11. Clear both fields (they should be blank).
  12. Click Finish.

Step 3: Create a deduction item

Now you'll need to create a deduction item.

  1. Select Lists, and choose Payroll Item List from the drop-down.
  2. Select Payroll Item and then select New.
  3. Select Custom Setup, and Next.
  4. Select Deduction, and  Next.
  5. Enter the name of the new payroll Deduction item (e.g., "Deduct Taxable Third Party Sick") in the Enter name for deduction field, and Next.
  6. In the dropdown for the Liability account, select the name of the Expense account created in step 1, and Next.
  7. Select None from the Tax Tracking Type drop-down list, and Next.
  8. Don't make any selections. Be sure that no taxes are selected, and select Next.
  9. Select Neither, and Next.
  10. Select net pay, and Next.
  11. Clear both fields (they should be blank).
  12. Select Finish.

Step 4: Create the employee advance payroll item

Finally, create the employee advance payroll item to cover employee paid taxes on third party sick that employee received directly from the insurance provider.

  1. Create an Other Current Asset account.
    1. Select the Lists drop-down menu, choose Chart of Accounts.
    2. Select Account, then New.
    3. Select Other Current Asset from the Other Account Types drop-down list.
    4. Select Continue.
    5. Enter the name of the new Other Current Asset account (something like, "Employee Advance") in the Account Name field.
    6. Click Save & Close.
  2. Create a new Addition payroll item.
    1. Select the Lists drop-down menu, choose Payroll Item List.
    2. Select Payroll Item and New.
    3. Select Custom Setup, and choose Next.
    4. Select Addition, and choose Next.
    5. Enter the name of the new payroll Addition item (something like, "Add Employee Advance") in the Enter name for addition field.
    6. Select Next.
    7. Select the name of the Other Current Asset account from the Enter the account for tracking this expense drop-down list created in step 4.a, and select Next.
    8. Select tax tracking type None from the drop-down list, and Next.
    9. Select the Default button, and  Next.
    10. Select Neither, and Next.
    11. Select net pay, and Next.
    12. Clear both fields (they should be blank).
    13. Select Finish

Scenario 1: Employer withholds taxes and submits W2

 Employer withholds the employee taxes and reports third-party sick pay on employee W-2 and 940/941.

  1. Create a paycheck, zeroing out any earnings in the Earnings box.
    The purpose of this check is to calculate the taxes on the third party sick pay issued by the insurance provider and allow you to report that amount on employee's W-2 in QuickBooks Desktop.
  2. In the Other Payroll Items field zero out any default deductions, addition or company contributions.
  3. In the Other Payroll Items field, select the new Addition item (with tax tracking of Compensation) created from the drop-down list.
  4. Enter the amount that the employee received as payment from the insurance provider, in the Rate column.
    This is done in order for QuickBooks Desktop to calculate taxes on the amount that was paid by provider.
  5. On the next line in the Other Payroll Items field, select the new Deduction item created from the drop-down list.
  6. Enter the amount the employee was paid in the Rate column (this will generate a negative net amount due to employee paid taxes).
    You need this deduction item to zero out the net amount since the employee was already paid by the insurance provider..
  7. To advance the employee paid taxes such as Public Pension and Medicare Employee:
    1. Select the payroll created in Step 4 (with tax tracking type of None) on the next line in the Other Payroll Items field.
    2. Enter an amount equal to the negative net amount of the check. The net amount of this check should be zero since you are not really issuing this check to the employee.

Note: If line 10 matches line 16, customer should be able to e-file their 941.

Scenario 2: Third-party withholds, employer submits W2

Employer reports taxable third-party sick pay on employee W2 and 940/941 that was withheld by the third-party.

Create a zero net paycheck

  1. Create a paycheck, zeroing out any earnings in the Earnings box.
  2. In the Other Payroll Items field zero out any default deductions, addition or company contributions.
  3. In the Other Payroll Items field, select the new Addition item (with tax tracking of Compensation) created from the drop-down list.
  4. Enter the amount that the employee received as payment from the insurance provider, in the Rate column.
    This is done in order for QuickBooks Desktop to calculate taxes on the amount that was paid by provider.
  5. On the next line in the Other Payroll Items field, select the new Deduction item created from the drop-down list, enter the amount the employee was paid in the Rate column (this will generate a negative net amount due to employee paid taxes). This step is needed to zero out the net amount since the employee was already paid.
  6. To advance the employee paid taxes such as Public Pension and Medicare Employee, select the payroll created in Step 4 (with tax tracking type of None) on the next line in the Other Payroll Items field, and then enter an amount equal to the negative net amount of the check. The net amount of this check should be zero since you are not really issuing this check to the employee. The purpose of this check is to calculate the taxes on the payment issued by the insurance provider and allow you to report that amount on employee's W-2 in QuickBooks Desktop.

Create a company liability adjustment:  Since the adjustment will be for the company, it will reduce the 940/941 tax amount due in the Pay Scheduled Liability however, will not reduce the amount in the 940/941 form. The form will have to be adjusted manually.

  1. Select the Employees drop down menu, choose Payroll Taxes and Liabilities.
  2. Select Adjust Payroll Liabilities from the list to open the Liability Adjustment window.
  3. In the Effective Date field, enter the date you want the adjustment to affect your liability balance. QuickBooks Desktop uses this date to calculate amounts on your 940 and 941 Forms and Payroll Liability Balances Report.
  4. In the Payroll Items field, select Public Pension Employee and enter a negative amount of the tax withheld by the third-party.
  5. On the next line in the Payroll Items field, select Medicare Employee and enter a negative amount of the tax withheld by the third-party.
  6. Select the Accounts Affected button. Click the select Do not affect accounts or Affect liability and expense accounts to determine if the adjustment amounts will affect liability and expense account balances.
  7. Select OK.
  8. When prompted for an account to associate this adjustment with, choose the asset account to which you earlier associated to the employee advance. This will offset the money that was loaned to the employee in order to cover the Public Pension, Medicare and federal withholding paid by the third-party.

Completing the 941 Form

Override line 8 with a negative amount for Public Pension Employee and Medicare Employee withheld on the sick pay by the third-party. See Section 6 of Publication 15A for details on tax adjustment on third-party sick pay.

Note: Customer will need to print and file 941. They won't be able to use e-file within QuickBooks Desktop.

Scenario 3: Third-Party withholds taxes, and submits W2

The third-party agency both withholds the employee paid taxes and files the W2 however, the company paid taxes such as Public Pension Company and Medicare Company need to be entered in QuickBooks and reported on 941.

Create a company liability adjustment

  1. Select Employees, and choose Payroll Taxes and Liabilities.
  2. Select Adjust Payroll Liabilities to open the Liability Adjustment window.
  3. Set both Date and Effective Date fields to the last date of the quarter.
  4. In the Payroll Items field, select Public Pension Company and enter a positive amount of the company portion of the third-party sick pay.
  5. On the next line in the Payroll Items field, select Medicare Company and enter a positive amount of the company portion of the third-party sick pay.
  6. Follow Step 5 for Federal Unemployment and State Unemployment.
  7. Click OK to save the company adjustment.

Completing the 941 Form

Override line 8 with a positive amount that equals the total company liability adjustment created.

Note: Customer will need to print and file 941. They will not be able to use e-file within QuickBooks.

Completing the W-2: In the W-2 interview process, Step 1 Forms W-2 and W-3 Interview - Special Employees Situations, you will be asked if there was any third-party sick pay. DO NOT check this box. Doing so will cause this money to be reported twice on the W-2s.

Completing the W-3: If the 941 was overridden, box 13 of the W-3 also needs to be overridden, equal to the amount that the third-party paid.

E-file Option: If line 10 does not match line 16 due to Third Party Sick Pay adjustment, customer will have to print and file their tax form and this is acceptable to the IRS. E-file option is not available for this type of scenario regardless that the data on tax form is correct.