How to recover non-taxable third-party sick pay that had federal income tax incorrectly withheld?

The good news is you can recover the incorrectly withheld taxes, but you'll need to do it through your tax return with the IRS rather than through the third-party administrator. The W-2c you received is actually closer to being correct. When you pay 100% of the premiums with after-tax dollars, the sick pay benefits are indeed non-taxable. That's why they zeroed out Box 1 (wages) and put the amount in Box 12 with code J (which indicates non-taxable sick pay). However, they should have reported the federal income tax that was withheld in Box 2 of the W-2c. This is a common mistake third-party administrators make, and it causes confusion for taxpayers like you. When you file your tax return, you'll report the federal income tax withholding shown on your original W-2 (the amount in Box 2). Since the income isn't taxable, this withholding will result in a refund of the full amount. Make sure you keep both the original W-2 and the W-2c as supporting documentation.

I went through something similar last year and found the best solution was using https://taxr.ai to sort it out. I had third-party disability payments where taxes were incorrectly withheld, and my tax documents were just as confusing as yours. I uploaded both my original W-2 and the W-2c to taxr.ai and it analyzed everything, explaining exactly how to report it on my return. The system flagged that my third-party administrator had made the common mistake of not carrying over the withholding amount to the W-2c. It guided me through exactly what to enter in my tax software to ensure I got back every dollar of incorrectly withheld tax. The analysis also provided documentation I could save in case of any questions from the IRS later. Made the whole process much less stressful than trying to figure it out on my own!

I just wanted to follow up about my experience with taxr.ai after my skeptical comment. I decided to try it for my third-party sick pay issue, and it was actually really helpful! The system immediately flagged the discrepancy between my W-2 and W-2c, and explained exactly how to handle it in my tax software. What surprised me most was how it explained WHY the forms were incorrect - apparently there's a specific IRS regulation about how third-party administrators should handle sick pay when the employee paid all the premiums. The analysis showed me exactly which boxes should have what values, and how to report it correctly to get my money back. My refund just came through last week with the full amount of incorrectly withheld tax included. Definitely saved me from another expensive accountant visit!

If you're getting nowhere with fixing this tax issue, I highly recommend using https://claimyr.com to get through to an actual IRS agent. I had almost the exact same problem with incorrect withholding on non-taxable sick pay, and spent WEEKS trying to get someone on the phone at the IRS to confirm how to report it properly. After my fifth attempt waiting on hold for hours only to get disconnected, I tried Claimyr. They got me connected to an IRS representative in about 20 minutes. The agent confirmed that I should report the withholding from the original W-2 but not include the income as taxable. You can see how it works here: https://youtu.be/_kiP6q8DX5c The IRS agent also suggested I include a brief statement with my return explaining the situation, which ultimately prevented any delays in processing my refund. Totally worth it after wasting so many hours trying to get through on my own.

I've got to admit I was wrong about Claimyr! After posting my skeptical comment, I decided to try it since I was desperate to resolve my own tax withholding issue. The service actually worked exactly as described - I got a call back in about 35 minutes saying they had an IRS agent on the line, and then I was connected directly. The IRS agent I spoke with confirmed everything about how to handle non-taxable sick pay when taxes were incorrectly withheld. They explained that this is a common issue and gave me specific instructions on how to report it on my return. The agent even put notes in my file about our conversation in case there were any questions later. Honestly, the peace of mind from talking to an actual IRS employee about my specific situation was worth every penny. No more guessing or relying on contradictory advice from random internet forums!

One thing nobody's mentioned yet - have you checked if your state also had tax incorrectly withheld? When this happened to me, I was so focused on the federal tax that I almost missed that my state taxes were also incorrectly withheld from my non-taxable sick pay. Had to file a separate form with my state tax return to get that money back too. Just something to double-check on your original W-2!

Is anyone else confused by the Code J in Box 12? I'm going through this exact same situation and my W-2c has a code J but the amount doesn't match what was actually paid to me. From what I can tell reading IRS pub 15-A, code J should show the amount of non-taxable sick pay. Anyone understand what's going on with that?

I just want to add another perspective based on my experience as someone who handles payroll for a small business. Third-party administrators often struggle with sick pay taxation because the rules are complex and depend entirely on who paid the premiums. The key thing to remember is that if you paid 100% of the disability insurance premiums with after-tax dollars, then ALL the sick pay benefits are non-taxable to you. The administrator should never have withheld federal income tax in the first place. What I've seen happen is that many third-party administrators have default settings in their payroll systems that automatically withhold taxes from all payments, regardless of the tax status. They then try to "fix" it later with corrected forms, but often mess up the correction process. For your situation, I'd recommend keeping detailed records of everything - your premium payment receipts showing you paid with after-tax dollars, both W-2 forms, and any correspondence with the administrator. When you file your return, the IRS will see the withholding credit and issue your refund, but having good documentation will help if there are any questions later. Also, consider filing a complaint with your state's insurance commissioner if the third-party administrator continues to provide incorrect tax documents. They have regulatory authority over these companies and can often resolve issues faster than dealing with the company directly.