Sick pay count as earned income?

Long-term disability benefits received prior to minimum retirement age counts towards the EITC. Does sick pay fall into that category?

Sick pay received for time off while working (i.e., short-term illness) shall be considered earned income when the person is still considered an employee by the employer and the person will be returning to work when recovered.

Milt Baker CPA

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That's kind of what I am asking.

Pub 596 (EIC) says "If you retired on disability, benefits you receive under your employer¹s disability retirement plan are considered earned income until you reach minimum retirement age."

That doesn't apply here because the taxpayer in question is neither retired or permanently disabled.

Pub 15 (Employers Guide) talks about sick pay and third party sick pay which is usually defined as an insurance to cover sickness or injury to an employee and are to be reported and taxed as wages. There is also disability insurance to cover long term or permanent disabilities.

Pub 596 (EIC) says "Payments you received from a disability insurance policy that you paid the premiums for are not earned income."

Does third party sick pay == disability insurance?

The free online version of Turbotax, TaxAct, and TaxCut all give a EIC refund of $4,716 when presented with W2 data of $12K in box 1 and "Third Part Sick Pay" in Box 13 - at least they are consistent - my question is are they correct?

Do you have a reference in a Pub or code?

What I am concerned about is the taxpayer who was injured toward the end of 2006 and had to have surgery. Taxpayer received sick pay for the first part of 2007 (until it ran out), but had to have a second, unrelated surgery (for a totally different reason) and could not return to work at all during 2007, so the sick pay was the only taxable income.

Well, I called the IRS today (twice) to try to get an answer, and as could be predicted I received two opposing answers.

On my first call (after putting me on hold for 10 minutes) the person wanted to know if the employee or employer paid for the sick pay policy. I said I didn't know but I thought that it was the employer. He said that, in that case, as long as the sick pay was taxable, then it was indeed to be counted as earned income when computing the EIC.

I later learned that the sick pay is actually a UNION benefit, so I called the IRS again. This time, even before I got to the point of it being a union benefit I was told that sick pay is never counted as earned income for calculating EIC.

I pointed out that on my earlier call I received a different answer. She put me on hold. When she came back she said her supervisor agreed with her answer that is was not earned income.

Having done a bit more research before I called the second time, I asked, then where and how do I exclude it from EIC, when the 1040 instructions for EIC says to use the amount from line 7 (which by definition has to include ALL W2 taxable income) and then subtract 1) Taxable Scholarship or grant, 2) Amount received while an inmate, or 3) Amount received as a pension... Those are the only choices - so where and how can I subtract the third party sick pay.

We also discussed Pub 596 which says earned income includes "Wages, salaries, tips, and other taxable employee pay. Employee pay is earned income only if it is taxable." If sick pay is to replace wages and is taxable, then why isn't it included in "other taxable employee pay" ?

Pub 596 also has a section that says what IS NOT earned income, and none of the exclusions would seem to cover sick pay.

She said, "Good points", and put me back on hold. When she came back, she said she would take my name and address and mail (or email) me an answer in 7-14 days from the "experts".

So I am still waiting for a definitive answer.

I was able to find one only tax court case that deals with the issue of sick pay and earned income, though not in the context of the earned income credit. In that case, Woodford v. Commissioner 71 T.C. 991 (1979), the court held that sick pay is earned income unless specifically excluded by law.

Sick pay is specifically determined to be earned income for withholding purposes under IRC §3402(o). I found no regulation dealing with the issue.

It seems to me that sick leave is more in the nature of payment for lost wages rather than payment for personal injuries, so I'd guess it should be included in earned income. But the law is not clear and I was able to find nothing authoritative either way (I didn't look through IRS publications or rulings). So you might be justified in taking either position.

Stu

That's good information, thanks.

I am not sure that sick leave is the same at third party sick pay. When I think of sick leave I think of an employer who gives sick days as a benefit that can be accumulated. When an employee is sick their pay continues as they use up their sick days but it is not accounted for in any special way on the employees w2 form - it is only an employer accounting.

Third party sick pay is paid by an insurance company whose premiums are paid as an employment benefit by the employer or in the case of the taxpayer I am talking about, by the employees union as a union benefit. Perhaps the best way to handle this is not to apply for the EIC at all but simply ask the IRS to figure the EIC by paper filing and writing "EIC" on the dotted line next to line 66a per the 1040 instructions. That would put the onus on the IRS rather than the taxpayer to figure the correct EIC and do the right thing. (My guess is that the tax software the IRS uses to figure this would count this as earned income just like all the other tax programs do and the taxpayer would get the EIC credit without anyone giving it a second thought.) That way, if the taxpayer is ever audited and higher-ups say, on no, that is not allowed, the taxpayer can say, "I didn't do it -you did".

Good point. I hadn't considered that.

Another good idea, but perhaps not foolproof. I met someone years ago who was in the army out of the country when he had to file his tax return. He said that he did the best he could, then checked the box to have the IRS figure the amount of his taxes, which they did. But then they came back to him a year or two later, saying they made a mistake, and wanted interest and penalties!

Stu

To make matters worse, if the IRS computes the return, the statute of limitations never ends. What is the penalty for filing an incorrect EIC, a fraudulent EIC? I know that if your file a false EIC then you are disbarred from the EIC credit for 10 years. Does the penalty apply when the IRS computes it -- seems it should not unless you give them misleading information. I think if you disclose that you want them to compute the EIC but attach a letter to your return saying that you are not sure if the the piece of income qualifies for the EIC, then there certainly should be no penalties and interest, but one never knows when dealing with governments.