Quick Hits
- The IRS and the Treasury Department issued guidance that addresses the employer tax credit for paid family and medical leave, which Congress made permanent and expended under the Working Families Tax Cuts Act (WFTC), a part of the comprehensive omnibus budget reconciliation bill of 2025.
- The employer’s leave policy must permit at least two weeks of paid family and medical leave to qualify for the tax credit.
- The WFTC introduced a new option for calculating the employer’s tax credit by the amount of premiums paid for paid leave insurance.
Employers that provide paid family and medical leave to their employees may be eligible for a tax credit. Section 45S of the Internal Revenue Code provides a general business credit for employers that maintain a written paid leave policy that meets certain statutory requirements. Originally enacted as a temporary provision under the Tax Cuts and Jobs Act (TCJA) of 2017, the credit was made permanent and expanded by the budget reconciliation bill signed into law on July 4, 2025. With important changes taking effect in 2026, now is the time for employers to understand how this credit works, whether they qualify, and what steps to take to claim the credit.
Background
The U.S. Congress created the Section 45S credit as part of the TCJA in 2017 to incentivize employers to offer paid leave benefits to lower-compensated employees voluntarily. Originally temporary, the credit was extended twice before the WFTC made it permanent. There is no employer size threshold. Employers of all sizes may qualify, regardless of whether they are subject to the federal Family and Medical Leave Act (FMLA).
The WFTC introduced several significant changes effective for tax years beginning after December 31, 2025, including a new premium method for calculating the credit, expanded definitions of qualifying employees, revised aggregation rules, and updated treatment of state and local leave mandates.
Who Is an Eligible Employer?
An employer may qualify for the credit if it has a written policy in place that meets three core conditions:
- Minimum leave duration: At least two weeks of annual paid family and medical leave for full-time qualifying employees, with a proportionate amount for part-time employees.
- Minimum rate of payment: A rate of payment of at least 50 percent of the wages normally paid to the employee (excluding overtime and discretionary bonuses).
- Noninterference protections: The policy must include language ensuring the employer will not interfere with employees’ FMLA rights under the policy or retaliate against employees who exercise their FMLA rights.
Who Is a Qualifying Employee?
Beginning in 2026, a qualifying employee must meet three criteria: (1) employed by the employer for at least one year (or at least six months at the employer’s discretion), (2) earned pay that did not exceed $96,000 or 60 percent of the highly compensated employee threshold under federal law in the prior year, and (3) customarily worked at least twenty hours per week.
What Qualifies as Family and Medical Leave?
The credit applies only to leave taken for purposes described in the FMLA, such as the birth or adoption of a child; caring for a spouse, child, or parent with a serious health condition; the employee’s own serious health condition; qualifying military exigencies; or caring for a covered servicemember. The leave may be provided under the FMLA or the employer’s own time off policy. General-purpose vacation, personal, or undifferentiated sick leave does not qualify. Leave under a short-term disability program may qualify if it otherwise meets the requirements.
For tax years beginning after 2025, state or locally mandated leave now counts toward the employer’s eligibility (i.e., meeting the minimum leave requirements). However, it remains excluded from the credit calculation itself. For example, if a state mandates two weeks of paid leave, and the employer provides four weeks total, only the nonmandated two weeks may be used to compute the credit amount.
How Is the Tax Credit Calculated?
- The Wage Method: The credit equals the applicable percentage of the wages paid to qualifying employees while on leave. The applicable percentage starts at 12.5 percent when the policy pays 50 percent of normal wages and increases by 0.25 percentage points for each percentage point above 50 percent, up to a maximum of 25 percent (when the employer pays 100 percent of the employee’s normal wages). For example, an employer paying 75 percent of normal wages has an applicable percentage of 18.75 percent. On $3,000 of leave wages, the credit would be $562.50.
- The Premium Method (new for 2026): The WFTC introduced an alternative calculation. Employers that maintain an insurance policy for paid leave may compute the credit based on the applicable percentage of premiums paid or incurred during the tax year, rather than on actual wages. Per Notice 2026-28, only premiums funding benefits that would qualify under the wage method are eligible. Employers may use both methods in the same year, but may not double-count the same leave.
Wages taken into account per employee cannot exceed the employee’s normal hourly wage rate multiplied by hours of leave taken, and no more than twelve weeks of leave per employee per year may be counted.
Section 280C(a) requires the employer to reduce its wage deduction by the credit amount. Employers may elect not to take the credit and instead preserve the full deduction. Wages used for the Section 45S credit cannot support other payroll-based tax credits.
Next Steps
The IRS and Treasury indicated that proposed regulations are forthcoming. Notice 2026-28 provides interim guidance that employers may rely on until new regulations are issued.
Employers may wish to adopt or update a written paid leave policy. Those without a qualifying policy, or with a policy that falls short of the statutory requirements, may want to draft or amend their policies before leave is taken.
Employers also may wish to evaluate which employees meet the tenure, compensation cap, and twenty-hour-per-week requirements. Consider whether electing the new six-month employment threshold captures additional eligible employees. It is important to carefully maintain records of leave taken, wages paid, and the applicable rate of payment per employee. The credit is claimed through IRS Form 8994.
Employers funding leave through insurance may want to assess whether computing the credit based on premiums, rather than wages paid, offers a simpler or more advantageous approach. In states with paid leave mandates, it is important to carefully distinguish mandatory leave benefits from voluntary leave benefits, as this affects both eligibility and the credit calculation.
Ogletree Deakins’ Employment Tax Practice Group will continue to monitor developments and will post updates on the Employee Benefits and Executive Compensation, Employment Tax, Leaves of Absence, and Military Workforce blogs as additional information becomes available.
Michael K. Mahoney is a shareholder in Ogletree Deakins’ Morristown office.
Stephen Kenney is an associate in Ogletree Deakins’ Dallas office.
This article was co-authored by Leah J. Shepherd, who is a writer in Ogletree Deakins’ Washington, D.C., office.
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