If your employee is temporarily out of work with a short-term disability, you can treat any sick pay he receives just like regular wages. You report sick pay in Box 1 with his other compensation. It also appears in Box 3 if you're withholding income tax on it and Box 5 for Social Security and Medicare. Alternatively, you can make out a second W-2 just covering sick pay.
If you use a separate W-2 for sick or disability pay, you report it as you would regular wages. Box 1 shows the amount of sick pay the employee must include in income. Box 2 reports any federal tax withheld. Boxes 3 and 4 report the amount subject to Social Security tax and the tax withheld; Boxes 5 and 6 do the same for Medicare.
If the payments come from a third party like an insurer, and the employee pays for the policy -- even if it's purchased through your health plan -- none of the disability pay is taxable income. If you pay 100 percent of the policy, 100 percent of the benefits are taxable; if your company pays 40 percent, then 40 percent of benefits are taxable. Report nontaxable disability payments in Box 12 of the W-2, using Code J.
Any payments for medical expenses related to sickness or disability aren't taxable, and don't go on the W-2. You also don't report benefits that aren't related to the employee being off from work. Two weeks sick pay is taxable, but a flat sum for losing a leg is not. Workers compensation payments are nontaxable and don't show up on the W-2.