Rev. Proc. 82-20

SECTION 1. PURPOSE

The purpose of this revenue procedure is to provide questions and answers about the taxability of sick pay under the Federal Insurance Contributions Act and the Railroad Retirement Tax Act.

SEC. 2 BACKGROUND

Pub. L. 97-123, page 314, this Bulletin, amended sections 3121(a)(2) and 3231(e) of the Internal Revenue Code regarding sick pay and disability payments. The first six months of sick pay paid to an employee on or after January 1, 1982, are subject to social security (FICA) and railroad retirement taxes. The following series of questions and answers explains some of the amendments made by Pub. L. 97-123.

SEC. 3 QUESTIONS AND ANSWERS

1. Q. With the changes made by Pub. L. 97-123 are all sickness or accident benefits paid by an employer or third party to or on behalf of an employee, taxable under FICA?

A. No, there are several exceptions:

(1) Benefits paid under a qualified plan as described in section 3121(a)(2) of the Internal Revenue Code, that makes provision for employees generally or for a class or classes of employees (and dependents if covered), if paid under a statute in the nature of a workmen's compensation act are not taxed.

(2) The portion of any benefit attributable to an employee's contribution towards the payment of accident and disability insurance premiums is not taxed.

(3) The payments made after the expiration of 6 calendar months following the last calendar month in which the employee worked for the employer, are not taxed. This exception, contained in section 3121(a)(4) of the Code is not affected by the changes made by Pub. L. 97-123.

(4) There is also a limited exception applying to benefits paid by certain third parties. Such benefits will not be taxed under FICA under the following conditions:

- The third party entered into a contractual relationship with the employer before December 14, 1981, under which the benefits are paid.

- Coverage by the third party for the employee's group ceases before March 1, 1982.

- No payment by the third party to the employee is made under the contractual relationship after February 28, 1982.

2. Q. For purposes of the new law, what is a "third party"?

A. A third party typically is an insurance company. A third party could also be a trust providing incidental sick and accident benefits as described in section 501(c)(17) of the Code; an employers' association funded to pay sickness and accident benefits; etc.

3. Q. Does Pub. L. 97-123 change how sickness or accident benefits are taxed under the income tax provisions?

A. No.

4. Q. What is the effective date of the new provisions?

A. The new provisions apply to remuneration paid after December 31, 1981. In the case of an employee who is not working and is receiving employer or third party sickness or accident benefits, the December 31, 1981 effective date does not mean that the 6 calendar months referred to in the answer to question 1 begin to run on January 1, 1982. On the contrary, if the 6 calendar month period has expired, the employee's benefits will not be taxed. So if the 6 calendar month period has expired on December 31, 1981 or earlier, remuneration paid on or after January 1, 1982 will not be taxed.

5. Q. When sickness and accident benefits are paid to or for an employee by a third party, what are the third party's tax responsibilities?

A. The third party is treated as a separate employer and is required to withhold and deposit the FICA tax, reflecting the amount deposited in its own Employer's Quarterly Federal Tax Return, Form 941. The third party will also prepare and file the Annual Wage and Tax Statement, Form W-2, and transmittal Form W-3 with the Service (or equivalent computer prepared tape or diskette) and provide the employee with a Form W-2 statement (or equivalent privately printed approved substitute). Form W-3 is being revised to reflect the reconciliation of FICA tax amounts on Form W-2 and Form 941 by these payers.

Notwithstanding these requirements, the third party will be relieved of the liability and the employer will be charged with the liability of paying the employer portion of FICA tax and for meeting the Form W-3 and Form W-2 requirements if the third party fulfills each of the following promptly: withholds the employee portion of the tax; meets the required due date for depositing the tax; and notifies the employer of the amount of wages involved. Pending the issuance of further Service guidance; (1) the notification requirement will be deemed to have been met if the third party notification is furnished within 2 working days after the day of deposit, and (2) similarly, for purposes of determining its own deposit due date on the employer portion of the tax, the employer will be deemed to have made payment to the employee on the 2nd work day following the third party's deposit of the employee portion of the tax.

6. Q. With regard to 5 above, for administrative convenience, may an employer contract with the third party to have the third party deposit the employer portion of the tax, as well as the employee portion?

A. The employer and third party may enter into such an agreement where the third party acts as an agent for the deposit of the employer portion of tax, and if desired, preparation of the Form W-2 as well. If there is an agreement covering preparation of Forms W-2 the Service does not require the third party and the employer to provide separate Annual Wage and Tax Statements to the employee--one statement reflecting the FICA wage amount paid and tax withheld by the third party, the other statement reflecting the amounts paid and tax withheld by the employer for the period for which the employee is in a working status. The Service will review this matter and if circumstances warrant, provide further guidance as to acceptable deviations from this general rule.

However, if the third party fails to "promptly" withhold and deposit the required tax, the Service will require the third party to be treated as a separate employer. See 5 above.

7. Q. Is any recognition taken in Pub. L. 97-123 for the short lead time before the changes are effective?

A. No penalties or interest will be assessed for failure to make timely payment of FICA taxes for sick pay paid during the period January 1, 1982 through June 30, 1982, to the extent the taxes are attributable to the P.L. 97-123 provisions, and the failure is due to reasonable cause and not to willful neglect and the taxes are paid on or before June 30, 1982. Assuming a reasonable cause for failure to make timely payment exists, the payer nevertheless remains liable for payment of the FICA tax. This means, for example, that a third party may find it necessary to arrange with an employer for the withholding of the employee's share of the FICA tax if the employee has returned to work prior to the start-up of the third party's withholding procedures. The Service encourages taxpayers to set up necessary procedures as soon as possible.

8. Q. Whether or not the third party is treated as a separate employer, it must withhold the employee portion of the tax as sick pay. Could not this result in withholding tax on wages in excess of the FICA base, $32,400 for 1982, in some circumstances?

A. When both the third party and the employer make payments to the employee, the cumulative payments during the year subject to FICA tax could exceed the base. However, the Service contemplates that it will furnish guidance in the near future on procedures to be followed by the appropriate withholding agent, either the third party or the employer.

9. Q. How do the new provisions affect the taxation of sickness and accident disability benefits paid by railroad employers or third parties making payments to railroad employees?

A. Amendments to the Railroad Retirement Tax Act closely follow the above changes in FICA. Sickness and accident disability benefits paid before the end of the six month calendar period (corresponding to the FICA provision--see answer to question 1) are taxed unless the benefits are: received as workmen's compensation; or received under the Railroad Retirement Act of 1974, Pub. L. 93-445, 1974-2 C.B. 440; or the benefits are paid under the Railroad Unemployment Insurance Act for days of sickness to the extent that the sickness is the result of on-the-job injury. Also, the provisions regarding third party payers and their responsibilities, and how they can be relieved of paying and depositing the employer share of RRTA tax and also be relieved of the Form W-2 responsibilities, follow the FICA provisions discussed above. In addition, the Service will review the Employer's Annual Retirement Tax Return, Form CT-1, to determine what changes are required in the Form or Instructions.

10. Q. When sickness and accident benefits are paid by a third party to or for an employee of a State or local government, what are the third party's responsibilities under Pub. L. 97-123?

A. Pub. L. 97-123 made several changes in the FICA to facilitate the reporting of payments and the collection and deposit of FICA taxes when third party payments are made to private sector employees. When a third party makes a sickness and accident benefit payment to a private sector employee, the third party is treated as the employer for FICA tax purposes. However, the liability for the employer share of the FICA taxes shift from the third party to the actual employer as soon as the third party has deposited the withheld employee FICA taxes and notified the actual employer of the amount of sick pay to be reported. Services performed in the employ of a State or political subdivision are specifically excluded from FICA coverage under section 3121(b)(7) of the Code. The exclusion also applies to services performed in the employ of an instrumentality that is wholly owned by one or more states or one or more political subdivisions. Social Security coverage for these services can be obtained only by means of a voluntary agreement between the State and the Secretary of Health and Human Services under the provisions of Section 218 of the Social Security Act. Under these agreements States pay contributions in amounts equal to the combined employer/employee FICA taxes for all covered services. Approximately 75 percent of employees of State and local governments occupy positions included under a State agreement.

Pub. L. 97-123 did not amend Section 218 of the Social Security Act. Therefore, the third party payers are not obligated to withhold and deposit employee Social Security contributions on sick pay to employees of State or local governments. The third party is not treated as the employer, and the Social Security Administration will continue to hold the State liable for all wage reports and contribution returns in these sick pay situations. The third parties are encouraged, however, to contact the employing entities and to cooperate with them in making whatever arrangements are necessary to ensure both correct and timely deposits of Social Security contributions under the State agreement and accurate wage reports. Under no circumstances should the third party deposit the employee contributions under the FICA provisions.

¹ Also released as News Release IR-82-34, dated March 4, 1982.