The Family and Medical Leave Act (FMLA) requires certain businesses to offer employees unpaid leave for qualifying situations, but there is no federal law that requires offering paid family and medical leave to employees. However, if employers voluntarily provide a paid family and medical leave benefit to employees, they may be eligible for the Paid Family and Medical Leave Tax Credit, IRC Section 45S.
First enacted as a two-year pilot program under the Tax Cuts and Jobs Act of 2017, the Paid Family and Medical Leave tax credit had been extended through 2020 by earlier appropriations legislation. Now employers providing paid family and medical leave that meets certain requirements can take advantage of a business tax credit through 2025 since the Taxpayer Certainty and Disaster Relief Act of 2019 extended the credit to cover 2021 to 2025 tax years.
Overview of Paid Family and Medical Leave Tax Credit
Paid Family and Medical Leave tax credit is therefore a dollar-for-dollar tax liability reduction. Eligible employers can claim it if they have a written policy in place to pay at least two weeks of family and medical leave to full-time employees (pro-rated for part-time) who have been with the organization for a year or more. The paid leave must be at least 50% of the wages normally paid to the employee.
Upon claiming the Paid Family and Medical Leave tax credit, employers reduce tax liability by the amount of the credit and the IRS determines the maximum credit they can receive.
The credit employers can claim for offering paid family and medical leave depends on the percentage of wages paid to a qualifying employee. The minimum tax credit employers can take is 12.5% of wages paid, and the maximum tax credit is 25%. The tax credit increases by 0.25% for each percentage point that exceeds 50% of wages normally paid to the qualifying employee.
To claim the Paid Family and Medical Leave tax credit, employers use Form 8994, Employer Credit for Paid Family and Medical Leave. They also need to file the General Business Credit form, Form 3800.
Employers interested in structuring a paid family and medical leave policy for purposes of claiming the tax credit can use IRS Notice 2018-71. This guidance provides 34 questions and answers and covers topics such as employer eligibility, minimum requirements, written policy requirements, minimum leave requirements, qualifying employees, and calculating and claiming the credit.
Paid Family and Medical Leave Tax Credit Requirements
To qualify for the Paid Family and Medical Leave tax credit, employers must meet certain requirements:
Having a Written Policy in Place
To qualify for the credit, employers need to establish a written paid family and medical leave policy, whether contained in a single document, multiple documents, or a larger leave policy. The written policy should address key information such as:
- Paid leave duration,
- Employee eligibility,
- Non-interference language stating that employers will not interfere with, restrain, or deny employees who want to use paid leave, and
- The policy’s effective date.
Offering Paid Family and Medical Leave to Every Eligible Employee
To receive Paid Family and Medical Leave tax credit, employers have to offer it to all eligible employees, including both full-time and part-time workers.
Under FMLA, employees become eligible for leave once they work for an employer for at least 12 months. However, eligible employees are also those who earn below an annual threshold. Qualifying employees in 2022 are those who earn less than $78,000 in compensation in the preceding year.
The employee’s leave of absence has to meet a qualifying FMLA reason, including:
- Birth, adoption placement, or foster care placement,
- Care of a spouse, child, or parent with a serious health condition,
- A serious health condition that prevents the employee from performing their job, or
- A situation that requires the employee’s attention due to the military deployment of a spouse, child, or parent.
Employers cannot claim the Paid Family and Medical Leave tax credit for employees who use unpaid or paid time off from work for vacations or illnesses.
Paying At Least 50% of Employees’ Wages
Employers must pay at least 50% of regular wages during the paid leave. This benefit does not include any paid family and medical leave provided under a state or local government program or required by a state or local law.
Providing At Least Two Weeks of Paid Leave
To meet the necessary requirements, employers have to offer all eligible, full-time employees at least two weeks of paid family and medical leave annually.
Some states already require employers to provide paid family and medical leave to eligible employees. If this is the case, they cannot claim the Paid Family and Medical Leave tax credit on any leave that the state pays an employee for. However, they can claim the credit on any paid leave offered to an employee which is above and beyond the paid leave required by state law if they meet the other IRS requirements.
Helping Employees and Ensuring Tax Savings
As a nonrefundable credit that may be used to offset federal income tax, the Paid Family and Medical Leave tax credit is beneficial for employers, but also for employees who can receive at least half their normal salary while they care for a newborn child or take time off from work for other qualifying reasons.
Employers who already provide paid family and medical leave must meet minimal additional administrative requirements. However, those not currently offering family and medical leave may struggle with the demands and significant costs associated with maintaining benefits and positions for employees out on leave. Still, benefits offered by the Paid Family and Medical Leave tax credit can outweigh the necessary efforts and resources, especially if employers decide to outsource the entire tax credit process. This allows them to pursue the credit successfully and put money back into their business with the help of professionals with deep experience in analyzing, documenting, and helping businesses claim wage-based tax credits.