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According to the IRS, mandatory employee contributions to state disability insurance, such as California SDI, are included in "state and local income taxes" that federal taxpayers who itemize on Schedule A can choose to deduct.

Meanwhile, California specifies that if an employer pays SDI for an employee (as distinct from withholding which merely facilitates the employee's payment of it),

the employee's wages increase by the amount of ... SDI paid. ... This amount ... should be included on the Form W-2, and should be reported by the employee as taxable income ... Also, the SDI paid by the employer should be shown on the Form W-2 as though the SDI amounts were actually withheld from the employee's pay.

This indicates that the amount paid directly "employer -> state" is treated as if it were paid "employer -> employee -> state" (i.e., like the normal case of withholding). Both the letter and the spirit of these rules seem to imply that the employee, as a federal taxpayer, will be imputed with additional income and an offsetting deduction (if itemizing state and local income taxes). This makes sense as taxes "should" be indifferent to mere labeling, e.g., if the employer simply gave a raise in lieu of paying SDI (in which case both the income and the deduction for the employee are clear).

Is there a source that explicitly confirms whether the federal deduction applies for employees in the case of SDI (California in particular) that is paid by the employer and imputed as income to the employee on the W-2?

  • What box on the W-2 does the SDI payment that went from employer->employee->state appear? Does that box have a letter code associated with it? – mhoran_psprep Nov 21 '17 at 11:16
  • @mhoran_psprep For the normal case of withholding, in at least one instance, the payment appears in W-2 box 14 on a line labeled "CASDI". Part of the answer might be to describe exactly how employer-paid SDI needs to appear on the W-2 to be deductible. – nanoman Nov 21 '17 at 11:31
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In the eyes of the IRS, there is no difference between an expense that is withheld from your wages and an expense that is employer paid.

In either case, if the expense is federally taxable, the amount will be included in your Box 1 wages on your W-2. The IRS doesn't know or care what your salary was "supposed to be." The amount is treated as part of the wages that you were actually paid.

As a result, it is included in your income, and if the expense is deductible on Schedule A, you can and should deduct it.


Here's a quick example. I'll make up some numbers. Let's say that your salary is $50,000, your CASDI premium/tax is $1,000, and the CASDI is being withheld from your paycheck. Box 1 on your W-2 would be $50,000.

Instead, what if your employer told you that your salary was $49,000, but they would kick in the necessary $1,000 for CASDI? Your paycheck would be the same amount, and Box 1 on your W-2 would still be $50,000. It's all the same to the IRS, because they don't know what your contract said at the beginning of the year that you were supposed to be paid; they only know what the employer ended up actually paying you over the course of the year.

  • Thanks -- do you have a citable source that specifically addresses this scenario? – nanoman Nov 21 '17 at 17:53
  • @nanoman The only thing I can point you to is the section of Pub 17 that you linked that says, "you can deduct mandatory contributions to state benefit funds withheld from your wages." To the IRS, these contributions are part of your wages no matter what you and your employer call them, because they are included in Box 1 of your W-2. – Ben Miller - Reinstate Monica Nov 21 '17 at 18:53

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