Any public agencies that have opted to participate in California’s State Disability Insurance (SDI) program and that voluntarily pick up any part of an employee’s SDI contribution will be required to treat such employer contributions as gross income and wages for federal employment tax purposes.
SDI provides partial compensation for wage loss sustained by an employee who is unable to work due to their own illness or injury, or for paid family leave reasons. SDI is generally funded through employee contributions, with no required employer contributions. Most public agencies are exempt from providing SDI to employees. (Unemp. Ins. Code, section 2606.) The only public agency employees who are subject to SDI are district hospital employees, public housing administration agency employees, certain state employees, and employees of public agencies that have elected SDI coverage. As such, some public agencies participate in SDI because they have elected coverage for all or select groups of employees.
On January 15, 2025, the IRS released Notice 2025-4, which guided the tax treatment of contributions and benefits paid in certain situations under a state’s paid family and medical leave programs. Most of Notice 2025-4 focused on how the state and employers should tax state-mandated employer contributions to such programs. However, California’s SDI program only requires employee contributions and does not mandate employer contributions. The applicable part of Notice 2025-4 is where it addresses how to tax an employer’s voluntary pick up of an employee’s otherwise required SDI contribution. Notice 2025-4 provided that employers that voluntarily pay any part of the SDI contribution on behalf of employees must treat the contribution as gross income and wages for federal employment tax purposes. IRS Notice 2025-4 initially provided that calendar year 2025 would be a transition period for purposes of IRS enforcement and administration.
The IRS recently released Notice 2026-6, which clarified that the transition period for employer pick-up contributions ended in 2025. Thus, beginning this year in 2026, public agencies that have opted into SDI and who either voluntarily or through negotiated agreement (e.g., memorandum of understanding or other contract) pick up and pay for any portion of an employee’s SDI contribution must include such contribution as gross income and wages for federal employment tax purposes. While Notice 2026-6 extended transition relief for other types of contributions, it made clear that there is no more transition relief for pick-up contributions. Any public agency that is picking up employees’ SDI contributions must report such contributions as taxable beginning in 2026.