Paid Family and Medical Leave Act Tax Credit Extended to Employers through 2025
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Last Updated: 01/06/2021
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Update: With the enactment of the Consolidated Appropriations Act, 2021, on Dec. 27, 2020, the employer tax credit for Paid Family and Medical Leave (45S) has been extended five years. The provisions now expire at the same time as many of the individual tax law changes at the end of 2025.
The article below was previously published Oct. 2, 2018, and contains details about the tax credit.
The Internal Revenue Service provided guidance for the Paid Family and Medical Leave Act (PFMLA) tax credit to employers that included an explanation of how the credit will work. The provision allows eligible employers that provide voluntary paid family and medical leave to claim a general business credit equal to as much as 25 percent of the benefit they pay to workers who take time off for reasons which would qualify for leave under the federal Family and Medical Leave Act (FMLA).
Another article published in February 2018 provides additional details on the tax credit.
Employers will claim the tax credit on Form 8994. The IRS did clarify many open questions in notice 2018-71, including the following highlights:
In general, employers that are members of control groups determine and calculate the credit independently from other members, instead of combining elements in assessing the credit across the entire group.
Eligibility and Written Policy Requirements
An eligible employer must have a written policy in place that satisfies certain requirements:
- Must cover all qualifying employees. A qualifying employee has worked for a year or more with the company and, in general, was not paid more than $72,000 in the prior year. To determine if an employee worked at least a year, the IRS is allowing the use of any reasonable method until further guidance. However, the IRS opined that it would not be a reasonable method to have a requirement that an employee work 12 consecutive months or have accumulated a minimum number of hours to be considered a qualifying employee. Only payments while an employee meets the definition of a qualifying employee count toward the credit.
- Must pay at least two (2) weeks annually (prorated for part-time employees) for qualified family medical leave under this provision. Part-time employees are those who customarily work fewer than 30 hours per week. Until further guidance is provided, employers may use any reasonable method to determine an employee’s regular hours. For part-time employees, the proportionate leave given must be at least the ratio of their customary hours to expected weekly hours by an equivalent employee that is not part-time.
- Must provide at least 50 percent of a qualifying employee’s normal wages while on leave. Overtime (unless regularly scheduled) and discretionary bonuses are excluded from normal wages. Until further guidance, employees who do not have a regular rate of pay (salaried or hourly) must use rules in the Fair Labor Standards Act (FLSA) for determining regular rate of pay.
- Must include “non-interference” protections for qualifying employees not covered by FMLA, as well as comply with the clause. The IRS provided an example of language that would satisfy this requirement:
(Employer) will not interfere with, restrain, or deny the exercise of, or the attempt to exercise, any right provided under this policy. (Employer) will not discharge, or in any other manner discriminate against, any individual for opposing any practice prohibited by this policy.
- There are no notice requirements with respect to this written policy. However, if they do decide to provide notice to qualifying employees of the written policy, it must be provided to all qualifying employees in a reasonable manner.
- The policy does not need to be uniform for all qualifying employees. Employers can have varying policies for different groups of employees as long as the minimum requirements for this credit are met for all qualifying employees. Essentially, some groups of qualifying employees can have more generous benefits, but all policies for qualifying employees must meet the minimum of these requirements.
- A written policy must be in place prior to leave being taken. There is a transition for the first taxable year for this requirement, since there was no guidance. This transition rule allows the policy in place after leave was taken to be in effect if the policy or amendment to a policy is adopted on or before Dec. 31, 2018, and the employer brings the compliance of the new policy retroactive for the entire term of the policy. This includes, if necessary, making retroactive payments to qualifying employees before the end of the tax year. Employers will need to determine if they are going to bring their policies in line retroactively in order to qualify for the credit.
What leave qualifies for the credit
The purpose for which an employee might take family and medical leave under section 45S (the tax credit) is the same as under title 1 of the FMLA. The IRS clarified that only plans specifically designated for one or more FMLA purposes and not for any other purposes qualify for the credit. It gave a narrow exception that would not disqualify the plan as eligible for the credit. The exception relates to the definitions of the individuals for whom care is permitted; if the definition in the employer’s plan is broader than what is required under FMLA, such as a grandparent, the plan may still be considered eligible for the credit.
However, the employer may not claim the credit for that particular leave to care for the individual outside those individuals specifically designated by FMLA. Also, the IRS clarified that paid leave provided under an employer’s short-term disability insurance policy can qualify, presuming that all the conditions outlined throughout guidance apply to the policy. In accordance with Internal Revenue Code section 45S, employers may provide leave (for the purpose of the tax credit) for the following:
- Birth of or to care for a son or daughter;
- Placement of a child with the employee for adoption or foster care;
- Caring for a spouse, son, daughter, or parent with a serious health condition;
- Employee’s serious health condition that makes them unable to perform functions of their position; and
- Additional exception included for family members or next of kin who are members of the armed forces.
Certain paid leave not eligible for credit
As previously indicated in the statute, any leave that is paid by a state or local government or required by state or local law is not considered for this credit. The IRS has opined on the dynamic if the employer resides in a jurisdiction that requires paid leave, but the employer's policy is more robust than the requirement. Essentially, the question is whether the excess above the requirement is credit-eligible. The IRS stated that to be eligible to claim the credit the excess beyond the minimum requirement needs to stand alone when testing if it met all the requirements listed above are met for all qualifying employees.
Tax credit likely to be used by businesses with established paid leave policies
Given that the paid family and medical leave tax credit originally was limited to two years, it was anticipated that it will be used primarily by employers that have already established voluntary paid leave programs.