FMLA tax credit: A chance to expand benefits and still save money
A tax credit for employers offering Paid Family and Medical Leave benefits has existed since 2018. But because of limitations in the existing law, most large employers, especially multi-state employers, tend not to qualify for the tax credit. Recent changes included in the One Big Beautiful Bill Act are going to significantly expand employers’ ability to claim the tax credit and save money on the PFML benefits that they offer.
This is a unique opportunity to save money. How often are you able to reduce benefits costs while doing what you're already doing today? For some, it could be a chance to actually expand paid leave benefits and still save money. Alternatively, paid leave benefits that may have been too expensive before, may now be affordable.
Key provisions that will make the tax credit more accessible
Employers can claim the tax credit on PFML benefits paid to qualifying employees for up to 12 weeks of leave. The current credit was scheduled to sunset in 2025, but the OBBBA extended the tax credit and made it permanent. The new law also revised some policy requirements that previously put the credit out of reach for many employers. Here are two key provisions go into effect in 2026 that we believe will make the tax credit much more accessible to employers.
Eligibility. Current law requires at least two weeks of paid leave to be provided to all qualifying employees with no minimum requirement for the number of hours an employee must work to qualify. If an employer fails to provide paid leave to one qualifying employee, the entire company is ineligible for the tax credit. Starting in 2026, employers still must provide paid leave to all qualifying employees, but they may exclude employees who work less than 20 hours a week.
Benefit amount. The employer’s PFML policy must provide at least 50% income replacement. Currently, employers are not permitted to include state-mandated benefits in the income replacement calculation. For example, if an employer has one employee in a state that provides 70% income replacement, to qualify for the credit, the employer will have to provide an additional 50% for a total wage replacement of 120% to remain eligible for the credit. The OBBBA has fixed this anomaly by permitting the employer to include the value of state-mandated benefits in the wage replacement calculation. The employer doesn’t get a tax credit on the state-mandated benefit but is eligible for a credit on the wages paid beyond the benefit paid by the state.
How much will the PFML tax credit be worth?
Calculating the credit is complicated. For most employers, the tax credit will need to be calculated at the individual claim level. Collecting the data from the plan administrator at the level of detail needed to complete the calculation may be difficult. Once you have the data, separating the paid benefits into employer spend that is eligible for the tax credit and employer spend that is not eligible for the tax credit is complex. The amount of PFML benefits paid for each specific leave should be distributed into one of two buckets, as shown below:
Spend that qualifies for the tax credit |
Spend that does not qualify for the tax credit |
Benefits paid to qualified employees who earn less than 60% of the highly compensated threshold in the prior year |
Benefits paid to non-qualifying employees who earn more than 60% of the highly compensated threshold in the prior year |
Benefits paid under leave policies that are only triggered by FMLA-protected events (e.g., short term disability, paid parental leave) |
Benefits paid under leave policies for non-FMLA-protected events or under policies triggered by a broad range of reasons (e.g., paid sick leave, PTO) |
Benefits paid for qualified leaves (e.g., benefits paid for up to 12 weeks of leave) |
Benefits paid for non-qualified leaves (e.g., benefits paid for leave beyond 12 weeks) |
By design, the credit will be more valuable to employers with lower-paid employees. The credit is only available on PFML wages paid to those earning less than 60% of the highly compensated employee threshold in the prior year ( for 2025, $160k x 0.6 = $96k). For example, if an employee who made $96,000 in 2025 goes out on leave in 2026, their wages will not qualify for the credit. In the FMLA tax credit modeling we’ve done for employers, we’ve found that the credit was not worth much to some very large employers with high-paid populations, while it was significant for others with a large population earning less than $96,000.
Interested? Here’s what to do now
Employers may want to review existing policies to determine if they qualify for the tax credit. Some policies may qualify with few if any edits. If the policies do not qualify, what are the gaps and how might they be filled? There's always the opportunity for employers to amend their policy and expand it. And one of the things we've seen in working with some employers on this issue is the cost of that expansion, in many cases, is less than the value of the entire credit. So for example, if you did have to expand benefits to cover part-time employees or hourly employees, in some cases, the cost of that expansion is less than the value of the credit overall. Expand benefits and still save money – that’s that definition of a win-win.
Listen to the replay of our recent webcast on paid leave to learn more.
