Short answer: Not automatically. A carrier that is not the employer’s agent does not have to withhold income tax, but the employee can request it with Form W-4S. Without it, a taxable benefit can leave the employee owing at filing time.
Under IRS Publication 15-A, sick pay paid by a third party that is not the employer’s agent is not subject to mandatory federal income tax withholding. The employee may give Form W-4S to the carrier to request withholding of a specific whole-dollar amount. The carrier should withhold on payments made 8 or more days after it receives the form.
The minimum the employee can request is $4 per day, $20 per week or $88 per month, depending on the payment period. Nothing is withheld from a payment if it would reduce the net payment below $10.
This matters most when the plan is employer-paid or paid pre-tax, because those benefits are taxable. A claimant who skips the W-4S can face a tax bill, and possibly an underpayment penalty, at filing time.