The federal tax credit for employers providing paid family and medical leave would extend beyond 2019 under legislation pending in Congress. A Senate bill (S 1628) would continue the credit for three years and improve employers’ ability to claim the credit. A House measure (HR 3301) would merely extend the credit for one more year without any other changes. The tax credit, enacted by Republicans as a two-year pilot program under the Tax Cuts and Jobs Act (PL 115-97), is currently set to expire Dec. 31, 2019.
Employers providing paid family and medical leave can take advantage of a general business tax credit for 2018 and 2019. The temporary credit ranges from 12.5% to 25% of wages paid to qualifying employees for up to 12 weeks of family and medical leave per taxable year. However, certain requirements and limitations put the credit out of reach for many employers with paid leave programs.
The Senate’s proposed Paid Family Leave Pilot Extension Act would not only extend the credit through 2022 but also remove some barriers present in the current program. The most notable change would eliminate the exclusion of wages paid during leave mandated by a state or local law when calculating the employer-provided benefit. Whether the House will agree to the Senate’s revisions is unclear. House and Senate talks on whether or how to continue the credit are intensifying as part of negotiations over broader legislation to extend a number of expired or expiring tax provisions that lawmakers hope to pass by year-end.
The remainder of this article gives a refresher on the requirements and restrictions on qualifying for the tax credit
For employers to claim the credit under Section 45S of the Internal Revenue Code (IRC), paid leave programs must meet several requirements. For example, employers must have a written policy describing the program, which must satisfy specific Family and Medical Leave Act (FMLA) requirements and offer at least two weeks of paid leave to certain full- and part-time employees. An employer doesn't have to offer each type of FMLA leave on a paid basis to qualify for the credit. If all conditions are met, the credit is available to any employer providing paid family and/or paid medical leave — even if the employer is exempt from the FMLA or the employee taking the leave is ineligible for FMLA protection.
To qualify for the credit, an employer must have a written paid family and medical leave policy — whether contained in a single document, multiple documents or a larger leave policy — that meets several criteria. The policy must be in place before the paid leave is taken. However, IRS Notice 2018-71 allowed retroactive payments for qualifying leave in 2018 to receive the credit, as long as employers adopted or amended a written policy before the end of 2018.
Specific policy requirements include the following:
─ To bond with a new child after birth or placement for adoption or foster care
─ To care for a spouse, son, daughter or parent who has a serious health condition
─ To care for the employee’s own serious health condition
─ To handle a qualifying exigency that arises because a spouse, son, daughter or parent’s active military duty or call to active duty
─ To care for a related service member with a serious injury or illness
[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, most employers have to include this noninterference language in their policies if they want to access the credit.
Employers can obtain the credit even if they don’t provide paid leave for all FMLA purposes or offer 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, as detailed below — suffices 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:
Many employers have policies that offer paid or unpaid leave for FMLA purposes, but broadly define “family” to include more relatives than the FMLA recognizes. For example, a covered employee is entitled to job-protected FMLA 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 FMLA and allow paid leave to care for other relatives — a sibling, grandparent, grandchild or domestic partner — who have a serious health condition. However, the employer can only claim the tax credit for a qualifying employee's paid leave to care for a spouse, son, daughter or parent with a serious health condition, as specified in the FMLA.
Disability plans — self-funded or insured — providing pay during leave for serious health conditions meeting FMLA’s definition qualify for the tax credit. This presumably is true only if the payments — whether made by an insurer or the employer — are taxable to employees, but IRS hasn’t addressed whether nontaxable STD benefits may count toward the tax credit. We believe this is the case for insured plans because the tax credit relies on the Federal Unemployment Tax Act (FUTA) definition of wages (IRC § 3306(b)), which include the first six months of sick pay received from an insurance company.
The method of paying for disability coverage determines whether the benefits are taxable to employees:
Employer-paid leaves for reasons not recognized by the FMLA don’t qualify for the tax credit. In addition, the tax credit does not apply to any wage payments during leave required by or paid under a mandatory state or local program. Finally, the law prohibits double-dipping, so otherwise qualifying paid leave is not eligible for the credit unless the employer reduces its annual deduction for employee compensation by a corresponding amount.
An employer's policy must specifically designate paid leave for FMLA-type purposes, even if it provides paid leave for other non-FMLA purposes. The tax credit is not available for employer-paid vacation, personal, PTO, medical or sick leave used for a non-FMLA purpose.
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. But an employer policy that provides two weeks of paid sick leave for ailments ranging from a minor cold or virus to a serious health condition does not satisfy the criteria, since the paid leave is not limited to FMLA-type purposes. For the same reason, a four-week PTO program that employees can use for any reason — including FMLA-type purposes — fails to satisfy the credit's conditions.
An employer can’t take the credit for leave paid by a state or local government program or required by a state or local law. Eight states and the District of Columbia have enacted paid family and medical leave mandates. In addition, Hawaii and Puerto Rico require paid STD leave. Thirteen states, the District of Columbia, and 22 localities mandate some type of accrued paid sick leave or PTO. Paid leaves under these or similar 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 (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-mandated leave payments exceed 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. In fact, some state programs reduce the standard benefit amount when a covered individual is concurrently receiving an employer benefit to avoid anyone receiving more than 100% of regular pay. This result is equally undesirable when employees and employers have to pay into the state-mandated program.
Multistate employers also may find the tax credit unworkable if they have some employees in a state mandating paid leave. Under the current law, an otherwise compliant multistate leave policy that offsets employer-provided paid leave by any benefits paid under a state or local leave program fails to satisfy the credit’s criteria. According to Notice 2018-71, the offsetting language means a class of qualifying employees may not be eligible for 50% of wages from the employer during the leave — and excluding any qualifying employees is impermissible. As a result, the entire policy fails — even for employees in states without a paid leave mandate, and even if employees in states with mandates still receive at least 50% of wages from the employer despite the offsetting provision.
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 leave benefits that employees receive. 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. Under current rules, the policy would fail because some employees are not eligible for 50% of wages from the employer during leave (due to the offset).
The Senate bill aims to make this provision less restrictive — and the tax credit more widely available — by allowing an employer policy to include the percentage of wages paid as state or local mandated leave benefits toward the 50%-of-wages threshold for credit-eligible paid leave. If the bill is adopted as currently drafted, however, the tax credit calculation would still exclude benefits paid under a state government program or required by a state or local law, so an employer would not receive credit for those amounts.
The tax credit equals the “applicable percentage” of wages paid to qualifying employees on family or medical leave for up to 12 weeks. The applicable percentage ranges from 12.5% to 25%, with the 12.5% minimum increasing by 0.25% for each percentage point by which the leave’s pay rate exceeds 50% of wages.
The credit is only available for paid family and medical leave provided to qualifying employees — generally, nonhighly compensated employees, whether full- or part-time. According to the statute, qualifying employees must meet two conditions:
Example. In 2019, Big Co. offers two weeks of paid family and medical leave to all full- and part-time employees who have worked for the company at least one year and made less than $72,000 in 2018. Assuming other requirements are met, Big Co. can take the tax credit for paid family and medical leave.
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.
Of course, an employer can provide paid family or medical leave to employees earning higher pay or employed for less than one year. But the employer can’t take the credit for leave payments to those employees.
Employers must reduce their annual tax deduction for compensation paid to employees by the amount of any credit taken for paid family and medical leave.
Before adopting or changing a leave policy to take advantage of the tax credit or factoring the credit into the budget, employers should keep a few things in mind: