Employers Seeking Tax Credit for Paid Family and Medical Leave Get IRS Guidance 

Employers Seeking Tax Credit for Paid Family and Medical Leave Get IRS Guid Lee Pei Ling Copyright 2017
23 January 2019

IRS Notice 2018-71 provides much anticipated guidance for employers looking to take the tax credit (Internal Revenue Code § 45S) for paid family and medical leave in 2018 and 2019. Because the guidance came out fairly late in the year, IRS will allow retroactive payments for qualifying leave in 2018 to receive the credit, as long as employers pay the leave and either adopt or amend a written policy before year-end. The notice also clarifies that the credit is limited to paid leave used for purposes defined by the federal Family and Medical Leave Act (FMLA). This article details what the IRS clarifications mean for employers.

Basics about paid family and medical leave tax credit

The 2017 Tax Cuts and Jobs Act (PL 115-97) provides a general business tax credit in 2018 and 2019 for employers providing types of paid leaves covered by the FMLA, regardless of whether the FMLA actually applies to the employer or employee. The credit is subject to the following conditions:

  • Voluntary paid leave policy. Employers must have a written policy offering at least two weeks of paid FMLA-type leave to qualifying full-time employees. The policy must also provide a prorated period of paid leave to qualifying part-time employees. Paid leave must be at least 50% of normal wages.
  • Qualifying employees. A qualifying employee must have worked at least one year for the employer and earned no more than $72,000 in the previous year. This figure is 60% of the tax code's 2017 and 2018 threshold ($120,000 per year) for identifying a highly compensated employee for certain employee benefit purposes.
  • Credit amount. The tax credit ranges from 12.5% to 25% of wages paid to qualifying employees on family or medical leave for up to 12 weeks, depending on what percentage of normal wages are paid. Paid leave required or paid under a mandatory state or local program is not eligible for the credit.

Notice 2018-71 provides 34 new FAQs, significantly expanding earlier informal IRS guidance. IRS has also posted for comment a draft Form 8994 with instructions for employers planning to claim the credit. Employers may get more questions answered when the IRS issues proposed regulations after the notice's comment period, which closed on Nov. 23.

Written policy specifications

To qualify for the credit, an employer must provide the benefits summarized above through a written paid family and medical leave policy — whether a single document, multiple documents, or part of a larger leave policy. The policy must be in place before the paid leave is taken (unless the special transition rule discussed in the next section applies). The policy must specifically provide paid leave for an FMLA-type purpose to all qualifying employees and include FMLA-type protections for all qualifying employees, even those not covered by FMLA.

Retroactive policy opportunity

To claim a credit for paid family or medical leave provided this tax year, employers can amend or adopt a policy that satisfies the IRS notice's requirements at any time before 2018 year-end. As long as a written policy meeting those requirements is in place on or before Dec. 31, 2018, and took effect on some date earlier in the year, any paid family or medical leave provided after the effective date but before year-end will be eligible for the tax credit. This is true even if the employer pays the leave retroactively.

Example. An employer's existing written parental leave policy pays full wages for two weeks when full-time employees take leave within the first 12 months after a child's birth or adoption. Before Dec. 31, 2018, the employer adopts an amendment that makes the paid leave available on a prorated basis to part-time employees and adds the noninterference language for any employees not protected by the FMLA. The amendment is retroactively effective to Jan. 1, 2018. Any paid leave provided to qualifying employees under the amended policy, including any retroactive payment made before year-end for part-time employees' previously unpaid parental leave, will be eligible for the 2018 tax credit.

This transition rule is only available for an employer's first taxable year beginning after Dec. 31, 2017. To qualify for the credit in the second taxable year, the employer must have a conforming policy in place before paid family or medical leave is taken.

Permissible FMLA purpose required

The notice clarifies that policy must provide paid leave only for an FMLA-protected purpose:

  • A child's birth or placement for adoption or foster care
  • Care for a spouse, son, daughter, or parent who has a serious health condition
  • Care for the employee's own serious health condition
  • A "qualifying exigency" that arises because a spouse, son, daughter, or parent is on active military duty
  • Care for a related service member with a "serious injury or illness"

A paid leave policy for more general purposes — such as sick leave or paid time off (PTO) — will not qualify the employer for the credit.

Example. An employer provides two weeks of paid sick leave for ailments ranging from a minor cold or virus to a serious health condition but offers no other paid leave program. Because the policy does not limit paid leave to FMLA-type purposes, the employer cannot claim the tax credit.

Example. An employer offers a four-week PTO program, which employees can use for any reason — including FMLA-type leave to help a family member prepare for active military duty or to care for a family member with a serious health condition. The program fails to satisfy the credit's conditions because it does not specifically designate paid leave for an FMLA-type purpose.

To qualify for the credit, an employer's policy must specifically designate paid leave for FMLA-type purposes, even if it provides paid leave for other non-FMLA purposes. For example, a paid leave policy that offers two weeks of paid leave for child bonding as a benefit separate from and in addition to a general PTO policy providing three weeks of paid leave could satisfy the Section 45S criteria for child-bonding leave.

Benefit variations for different FMLA types of leave permitted. An employer can obtain the credit even if its paid leave policy doesn't cover all FMLA purposes or provide the same benefit or duration for all types of FMLA leave. A policy that provides paid leave for one or more FMLA-type purposes (including a short-term disability (STD) policy) will suffice if all other conditions are met. A policy can even extend more generous benefits or longer leaves for some FMLA-like purposes than others. For example, an employer's policy can provide:

  • 10 weeks of leave at 100% pay to bond with a new child, but only six weeks of leave at 60% pay to care for a family member with a serious illness
  • Two weeks of FMLA-type leave at 50% pay for all qualifying employees and an additional two weeks of FMLA-type leave at 50% pay for qualifying employees at the company for five or more years.

Broader definition of "family" than FMLA permitted. Many employers have policies in place that offer paid or unpaid leave for FMLA purposes, but broadly define "family" to include more relatives than the FMLA recognizes. For example, under the FMLA, a covered employee is entitled to job-protected leave to care only for a spouse, son, daughter, or parent with a serious health condition. Notice 2018-71 clarifies that an employer policy may go beyond the federal FMLA and allow paid leave to care for other relatives — a sibling, grandparent, grandchild, or domestic partner — who have a serious health condition. However, in this situation, the employer can only claim the credit for paid leaves provided to care for a qualifying employee's spouse, son, daughter, or parent as specified in the FMLA.

Exclusion of qualifying employees not permitted

The notice clarifies that the paid leave must be available to all qualifying employees, regardless of hours worked. If the policy excludes a group of otherwise qualified employees (such as collectively bargained employees), the employer will not be eligible for the tax credit. To determine whether an employee has been employed for at least one year, employers may use any reasonable method, as long as it does not require a minimum number of hours worked.

Protections for qualifying employees not eligible for FMLA

The notice clarifies that the employer's policy must include FMLA-type protections for qualifying employees taking paid family or medical leave, even if they or their employer are not covered by FMLA. A paid leave policy covering FMLA-ineligible employees or offered by an FMLA-exempt employer must contain the following "non-interference" language:

[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.

Because the paid leave must be available to qualifying employees without regard to hours worked and at worksites that may not be subject to FMLA, many employers looking to take advantage of the credit will have to include this noninterference language in their policies.

Coordination with state or local paid leave requirements

Benefits paid pursuant to a state or local law aren't eligible for the tax credit. Six states and the District of Columbia have enacted paid family and medical leave mandates. In addition, five states mandate some sort of paid STD leave, and 11 states plus the District of Columbia mandate some type of paid sick leave. Leaves paid under these or similar city or county mandates are ineligible for the tax credit.

Employer-paid amounts that exceed the state-required benefit may qualify for the credit if the excess benefit independently satisfies the wage threshold required under Section 45S. Specifically, the written policy must provide for the minimum rate-of-pay requirement (50% of wages) after excluding any leave paid or required by state or local law.

Employers subject to state paid leave laws may find the federal family medical leave tax credit unworkable as a practical matter. When the state mandate requires payments of more than 50% of wages — and employers must provide at least an additional 50% to claim the federal tax credit — some employees would receive more than 100% of pay while on leave. Few employers would view that as a reasonable result.

Less clear is the consequence of state mandates on an otherwise compliant multistate employer program. Consider the following:

Example. An employer's policy provides six weeks' leave at full wages for a qualifying employee to bond with a new child. The benefit runs concurrently with and is offset by any state-mandated family and medical leave benefits that may be received by employees living in states with such mandates. The state-paid benefits may or may not equal 50% of wages, depending on the employee's average weekly wage and the state's benefit cap.

Does this employer's entire policy fail to qualify for the credit, or does it fail only with respect to employees in states that mandate family and medical leave benefits? Or does the policy survive, so the employer remains entitled to tax credits for any paid leave that is equal to or exceeds 50% of wages after the offset provision? Guidance in the IRS notice arguably implies the entire policy fails because the offsetting language means a class of qualifying employees (those in states mandating paid family and medical leave) are not eligible for 50% of wages from the employer during the leave — and those employees apparently can't be excluded from the policy. Further IRS guidance on this point would be helpful.

Employer considerations

Before adopting or changing a leave policy to take advantage of the new tax credit or factoring the credit into the budget, employers should keep a few things in mind:

  • Employers with employees in states with paid leave mandates should discuss the credit with tax advisers and determine whether the credit is available.
  • Section 45S does not require any employee notice about the employer's paid leave policy, but if notice is given, the employer must supply this information in a manner reasonably designed to reach all qualifying employees.
  • The duration of prorated paid leave for part-time employees must at least equal the ratio of a part-timer's expected weekly work hours to a full-timer's expected weekly work hours. Employers may use any reasonable method to determine how many hours an employee is expected to work in a week, but any employee who customarily works less than 30 hours per week should be considered part-time.
  • For STD benefits to qualify for the tax credit, the disability policy must not have eligibility provisions inconsistent with Section 45S requirements. So an STD policy must be available to all qualifying employees and must not contain, for example, any pre-existing condition exclusions.
  • The Section 45S credit applies only to wages as defined by Section 3306(b) (without regard to the $7,000 FUTA limit). Employers cannot take family and medical leave tax credit and other types of Section 38 general-business credit for the same wages. Finally, any deduction for wages or salaries paid in the taxable year will be reduced by the credit received for paid FMLA leave. .
  • The credit is set to expire at the end of 2019, and a proposal to extend the credit has not received much traction in Congress. As a result, employers that offer paid leave benefits for the first time to take advantage of this credit may face the choice of continuing the benefit without any tax break or ending the benefit if the credit expires after next year.
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