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Third party sick pay (3PSP) is a disability insurance benefit that provides employees with partial or full wage benefit payments while on long-term medical leave. The payments are not made through the employer, but through an insurance company, union plan, or a state temporary disability plan.
Under the IRS Code, Disability "Sick Pay" benefits, third party sick pay benefits may be included in the gross income of insured members and may be subject to tax if the employer pays part or all of the premium for the coverage. The extent to which benefits are taxable is based on the portion of the premium that is paid by the employer.
Any portion of sick pay paid by a third party that is attributable to the employee’s own premium contribution is not wages and is not subject to withholding. However, when premium contributions are made with pre-tax dollars under the employer’s cafeteria plan and deferred from taxation, then any sick pay paid by a third party to the employee is subject to tax withholding.