Trading Disability For Wages


Today TaxMama hears from Dave in the Tax Quips Forum with an odd question. “I received SDI for two months in 2010 and gave it to my employer so that I could retain full pay.  It does not show on my W-2 and I was taxed for full pay.  How do I handle the SDI payments that went to my employer on my taxes?” 


Dear Dave,

How very odd! I have never heard of that kind of arrangement before.

Let’s see. Random thoughts, here.

1) SDI income is not taxable to you in the first place. Typically, you cannot deduct expenses in relation to non-taxable income.

2) This is an arrangement with your employer. Please check with your payroll department to find out what is normally done with this kind of arrangement. Surely, this is not the first time they have done this.

3) It seems that you have traded a small amount of money for a much larger amount of money. That sounds like a good thing, right?

4) Did part of your compensation get designated as sick pay? If I am not mistaken, sick pay isn’t taxed for Social Security and Medicare. Check on that with your payroll department, too.

Perhaps someone else here can come up with a better idea. I’ll turn this into a TaxQuip today and see.

 And remember, you can find answers to all kinds of questions about returning compensation to an employer and other tax issues, free. Where? Where else? At

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2 thoughts on “Trading Disability For Wages

  1. TaxMama says:

    Thanks Lucie,

    Yes, I knew there was some SS/Medi adjustment for sick pay.
    That long? 6 months?
    Clearly, being out two months was not enough.

    Yes, I agree. It would have been more humane of his company to supplement the SDI, instead of purely replacing it. Two months of purely tax-free income would be better.

    However, the fact that his company offered him full pay in the first place. That is a big help, regardless. So let’s not lose sight of that, while looking at the tax treatment issue.

    Of course, someone should bring this up the company for future issues. Then their employees can have no reservations about the company’s generosity.

    Thanks, Lucie.


  2. Lucie Sample says:

    Well, TaxMama, I believe sick pay is subject to Social Security and Medicare taxes for the first six months a person is sick. Only after six months are the payments exempt from these taxes (but not income tax).

    And if Dave received unemployment in 2010 as well as SDI, the disability payments will show up on his Form 1099-G and quite possibly get taxed.

    Perhaps a better arrangement with Dave’s employer would have been to supplement his SDI payments with the sick pay (instead of taking the SDI) so that the total of both equals his regular pay. That way, he’d have paid less income tax while not suffering financially from a pay decrease.

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