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Track and report third-party sick pay in QuickBooks Desktop Payroll Enhanced

SOLVED•by QuickBooks•14•Updated November 15, 2023

Learn how to track third-party sick pay on paychecks and report these payments on your payroll tax forms in QuickBooks Desktop Payroll Enhanced.

Third-party sick pay is a form of compensation paid to your employees who can’t work due to illness or injury. It can be provided by insurance providers, trusts, or other third parties.

Find out how to report third-party sick pay to QuickBooks Online Payroll and QuickBooks Desktop Payroll Assisted.

Note: Not sure which payroll service you have? Here's how to find your payroll service.

Step 1: Determine what type of third-party sick pay you have
Step 2: Create an expense account
Step 3: Create an addition payroll item
Step 4: Create a deduction payroll item
Step 5: Create an employee advance payroll item (if applicable) for taxable third-party sick pay only     
Step 6: Report third party sick pay to your employees’ paycheck and payroll tax forms

Step 1: Determine what type of third-party sick pay you have

Check the Explanation of Benefits (EOB), contact the third party to obtain it.

  • Taxable 
  • Non-taxable

How it’s reported:

  • You withhold taxes and file the W-2
  • Third-party withholds taxes, you file the W-2 
  • Third-party withholds taxes and files the W-2

Step 2: Create an expense account

Create an expense account to track your employees' third-party sick pay.

  1. Select Lists, then Chart of Accounts.
  2. Select the Account ▼ dropdown, then New.
  3. In the Add New Account window, select Expense, then Continue.
  4. Enter the name of the new expense account in the Account Name field.
  5. (Optional) Select the Subaccount of checkbox, and from the ▼ dropdown, select Payroll Expenses.
  6. Select Save and close.

Step 3: Create an addition payroll item 

There are two tax tracking types you can use for third-party sick pay.

  • Compensation is used when you're reporting taxable third-party sick pay. The third-party sick pay amount will appear in box 1 of the W-2 form.
  • Non-taxable Sick Pay is used when you’re reporting non-taxable third-party sick pay. Reported in box 12, code J of the W-2 form.
  1. Select Lists, then Payroll Item List.
  2. Select the Payroll Item ▼ dropdown, then New.
  3. Select Custom Setup, then Next.
  4. Select Addition, then Next.
  5. Enter a name for the Addition item. Select Next.
  6. In the Expense Account window, select the expense account you created in Step 2, then Next. 
  7. In the Tax Tracking type window, select: 
    • Compensation for taxable third-party sick pay
    • Non-taxable Sick Pay for non-taxable third-party sick pay
  8. Select Next three times.
  9. In the Gross vs. net window, select net pay (only applies to Non-taxable Sick Pay tax tracking), then Next.
  10.  Select Finish.

Step 4: Create a deduction payroll item 

Use this payroll item to remove the third-party sick pay amount that the employee already received.

  1. Select Lists, then Payroll Item List.
  2. Select the Payroll Item ▼ dropdown, then New.
  3. Select Custom Setup, then Next.
  4. Select Deduction, then Next.
  5. Enter a name for the new deduction item such as “Deduct third-party sick pay”. Select Next.
  6. In the Liability account ▼ dropdown, select the expense account you created in Step 2, then Next. 
  7. Select None from the Tax Tracking Type ▼ dropdown. Select Next three times.
  8. In the Gross vs. net window, select net pay, then Next.
  9. Select Finish.

Step 5: Create an employee advance payroll item (if applicable)  for taxable third-party sick pay only

Only do this step for taxable third-party sick pay, Scenario 1 and Scenario 2 and if your employee hasn't returned to work yet.

  1. Create an Other Current Asset account
    1. Select Lists, then Chart of Accounts.
    2. Select the Account ▼ dropdown, then New.
    3. Select Other Current Asset from the Other Account Types ▼ dropdown.
    4. Select Continue.
    5. Enter the name of the new Other Current Asset account in the Account Name field.
    6. Select Save & Close.
  2. Create an employee advance payroll item
    1. Go to Lists, then Payroll Item List.
    2. Select Payroll Item ▼ dropdown, then New.
    3. Select Custom Setup, then Next.
    4. Select Addition, then Next.
    5. Enter the name of the item, such as Employee Advance. Select Next.
    6. In the Expense Account window, select the Other Current Asset account you just created, then Next.
    7. Set the tax tracking type to None. Select Next.
    8. Select Next twice. 
    9. Select net pay in the Gross vs. net window, then Finish.

Step 6: Report third-party sick pay to your employee’s  paycheck and payroll tax forms

Here are some scenarios to help you figure out how to report third-party sick pay. To learn more, check out IRS Publication 15-A.

  1. Track the third-party sick pay on a regular paycheck or create a third-party sick pay paycheck-only.
  2. Create and file your 941 form. If line 6 matches line 10, you should be able to e-file the form.
  3. Create your employees W-2. Sick pay wages will be reported in Box 1.

If you report taxable third-party sick pay on your employee W-2, 941 and 940 that was withheld by the third-party, you need to:

  1. Track the third-party sick pay on a regular paycheck or create a third-party sick pay paycheck-only.
  2. Create company liability adjustment for Social Security Employee and Medicare Employee.
    1. Go to Employees, then Payroll Taxes and Liabilities. 
    2. Select Adjust Payroll Liabilities.
    3. In the Date and Effective Date fields, enter the date you want the adjustment to affect your liability balance. 
    4. In the Adjustment is for: section, select Company Adjustment.
    5. Under the Item Name column, select Social Security Employee and Medicare employee and enter a negative amount of the tax withheld by the third-party.
    6. Select Accounts Affected.
    7. Select Affect liability and expense accounts.
    8. Select OK to close the Affect Accounts window.
    9. When prompted for an account to associate the adjustment with, select the Asset Account associated with the employee advance payroll item.
  3. Create and file your 941 form. 
  4. Override line 8 with a negative amount for Social Security Employee and Medicare Employee withheld on the sick pay by the third-party. See Section 6 of Publication 15A for details on tax adjustments on third-party sick pay.
  5. Create your employees W-2. Sick pay will be reported in Box 1.

Note: You’ll need to print and mail your 941 form. You can’t e-file because of the third-party sick pay adjustments.

If the third-party agency withholds the employee-paid taxes and files the W-2 for sick pay, you don’t need to create a zero net paycheck. However, you still need to create a liability adjustment in QuickBooks to report company-paid taxes on Form 941 and Form 940.

  1. Create a company liability adjustment
    1. Go to Employees, then Payroll Taxes and Liabilities. 
    2. Select Adjust Payroll Liabilities.
    3. In the Date and Effective Date fields, enter the date you want the adjustment to affect your liability balance. 
    4. In the Adjustment is for: section, select Company Adjustment.
    5. Under the Item Name column, select Social Security Company and Medicare Company and enter a positive amount of the company portion of the taxes calculated from third-party sick pay.
    6. Follow Step 1.e for Federal Unemployment and State Unemployment.
    7. Select Accounts Affected.
    8. Select Affect liability and expense accounts.
    9. Select OK twice.
  2. Create and file your 941 form.
  3. Override line 8 with a positive amount equal to the total Social Security company and Medicare Company liability adjustment created. Then, print and mail your 941. You can’t e-file because of the third-party sick pay adjustments. 
  4. Create your employee’s W-2. 
  5. In the W-2 interview process, Step 1 Forms W-2 and W-3 Interview - DO NOT check Special Employees Situations box.
  6. Override box 13 of the W-3, equal to the amount that the third-party paid.

If you’re reporting non-taxable third-party sick pay, you can track it on your employee’s regular paycheck or on a separate paycheck. Then file your 941 form and your employee’s W-2. Sick pay will appear in the W-2 form Box 12, code J.

Track third-party sick pay on paychecks

You can report third-party sick pay on a paycheck with regular wages or create a third-party sick pay paycheck-only.

Add a taxable third-party sick pay to regular paycheck

If you have taxable third-party sick pay, you must report it with a regular paycheck to allow taxes to be withheld from actual wages. 

  1. Create your employee paycheck.
  2. Select Open Paycheck Detail.
  3. In the Earnings Item section, enter the Earning item, Rate, and Hours (for hourly employees). 
  4. In the Other Payroll Items section, select the Addition item with Compensation tax tracking, created in Step 3.
  5. Enter the sick pay amount received from the insurance provider in the Rate column.
  6. On the next line in the Other Payroll Items field, select the Deduction item you created in Step 4, then enter the sick pay amount in the Rate column.
  7. Select Save & Close, then Continue. 
  8. Select Create Paychecks.

Create a taxable third-party sick pay paycheck-only for an employee who hasn’t returned to work yet

If your employee hasn't returned to work yet, and the sick pay crosses over to another calendar year, create a zero net paycheck with an employee advance payroll item added to cover the taxes.

  1. Create your employee paycheck.
  2. Select Open Paycheck Detail.
  3. Clear all payroll items in the Earnings section.
  4. In the Other Payroll Items section, select the Addition item with Compensation tax tracking, created in Step 3.
  5. On the next line in the Other Payroll Items field, select the Deduction item you created in Step 4, then enter the sick pay amount in the Rate column.
  6. On the third line in the Other Payroll Items field, select the Employee Advance payroll item created in Step 5.
  7. Enter an amount equal to the negative net amount of the check. The net amount should be zero.
  8. Select Save & Close to go back to the Enter Payroll Information window.
  9. Select Continue, then Create Paychecks.

Create a paycheck for non-taxable third party sick pay

You can report a non-taxable third-party sick pay along with the regular wages or create a non-taxable third-party sick pay paycheck-only.

  1. Create your employee paycheck.
  2. Select Open Paycheck Detail. 
  3. If you’re reporting non-taxable sick pay along with the regular wages, enter the Earning item, Rate, and Hours (for hourly employees). Otherwise, clear all payroll items in the Earnings section
  4. In the Other Payroll Items section, select the Addition item with Non-taxable Sick Pay tax tracking, created in Step 3.
  5. Enter the sick pay amount received from the insurance provider in the Rate column.
  6. On the next line in the Other Payroll Items field, select the Deduction item you created in Step 4, then enter the sick pay amount in the Rate column.
  7. Select Save & Close to go back to the Enter Payroll Information window.
  8. Select Continue, then Create Paychecks.

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