As businesses seek ways to compete for workers in a tight labor market and counter the “she-cession,” a business tax credit can help employers provide paid family and medical leave and bolster their benefits package for working parents and caregivers. Originally enacted in the Tax Cuts and Jobs Act of 2017 and available through 2025, the Section 45S Employer Credit for Paid Family and Medical Leave is designed to cover up to 25% of the cost to employers of providing paid family and medical leave and help expand access to the benefit.
Scope and Eligibility
Employers of any size can claim this non-refundable paid leave tax credit. To qualify, employers must have an active written policy providing all eligible employees access to at least two weeks of paid family and medical leave annually, paid at 50% or more of normal wages. Employers who provide short-term disability policies that fulfill the credit’s requirements qualify for the credit. The benefit that employers offer must cover leave for at least one of the following reasons:
- To care for a newborn child, newly adopted child, or newly placed foster child;
- To care for a spouse, child, or parent who has a serious health condition;
- To recover from a serious health condition that makes the employee unable to perform their job;
- For any qualifying exigency due to an employee’s spouse, child, or parent being on covered active duty (or having been notified of an impending call or order to covered active duty) in the Armed Forces; or
- To care for a service member who is the employee’s spouse, child, parent, or next of kin.
Employers can claim the credit for up to 12 weeks of paid leave benefits. The credit only applies to paid leave benefits used by full- or part-time employees who have worked for the employer for at least one year and who earned no more than $78,000 in 2021. The $78,000 earnings threshold is equivalent to 60% of the “highly compensated employee” limit ($130,000 in 2021), which periodically increases with cost of living adjustments. To be eligible for the tax credit, employers must offer paid leave benefits to all workers who meet eligibility requirements. They can use “any reasonable method” to calculate normal wages for the purpose of determining employee eligibility and the amount of the paid leave benefit.
To be eligible for the credit, employers must also include specific non-discrimination language in their written policy, as well as “non-interference” language (specifying that the employer will not interfere with any attempt to use the benefits outlined in the policy) for any employees not covered by the Family and Medical Leave Act.
Parameters and Size of the Tax Credit
For eligible employers, the tax credit offsets 12.5% to 25% of the cost of wages paid to employees on paid leave, depending on the generosity of the benefit. The credit covers 12.5% of paid leave that compensates workers at 50% of their normal earnings. For paid leave benefits with higher wage replacement rates, the credit increases on a sliding scale until reaching a maximum of 25% of the cost of paid leave that compensates workers at 100% of their normal earnings.
Variation in Credit Use
Employers can offer a more expansive paid leave benefit—covering, for example, additional reasons for leave, additional family members for whom caregiving leave is allowed, or employees with a tenure shorter than one year or earning more than $78,000—and remain eligible for the tax credit. But employers can only claim the credit for the types of leave and workers outlined above.
Employers can also offer varying benefit levels to their employees and remain eligible for the tax credit as long as their paid leave policy fulfills the minimum requirements for all employees. For example:
- An employer offering two weeks of leave paid at 50% of normal wages to junior staff and four weeks of leave paid at 70% to senior staff can claim the tax credit on all leave benefits paid to eligible employees.
- An employer offering two weeks of leave paid at 25% of normal wages to employees who have worked for the company for one to three years and six weeks of leave paid at 75% of normal wages to employees with longer tenures is not eligible to claim the credit for any paid leave benefits.
- An employer offering four weeks of leave paid at 100% of normal wages for the birth, adoption, or foster placement of a child; two weeks of leave paid at 100% of normal wages to recover from a serious health condition; and one week of leave paid at 100% of normal wages to care for a spouse, child, or parent with a serious health condition can claim the credit for leave benefits in the first two categories. The employer cannot claim the credit for the caregiving leave benefit.
Interaction with State and Local Requirements
The paid family and the medical leave tax credit is not available to cover the costs of benefits required by state or local law (or benefits paid by state or local government). An employer required to provide paid leave can receive the tax credit only if their policy meets the minimum tax credit eligibility requirements on top of any leave benefit required by state or local law. For example, a company required by local law to provide at least two weeks of paid leave with at least 50% wage replacement can become eligible for the tax credit in two ways: by providing at least four weeks of leave or by providing 100% wage replacement for the two required weeks. In the first case, that employer could claim the credit for the third and fourth week of leave only; in the second case, the employer could claim the credit for 50% of the wages paid during leave.
An employer required by local law to provide a leave benefit paid at more than 50% of normal wages would generally not be able to claim the credit by providing a higher wage replacement. Instead, that employer could claim the credit on additional leave provided if that additional period of leave lasts for at least two weeks and entails a wage replacement rate of at least 50%.
Claiming the Tax Credit
To claim the credit, eligible employers must file IRS Form 8994, Employer Credit for Paid Family and Medical Leave, and IRS Form 3800, General Business Credit, with their annual tax return. To calculate the amount of the credit, employers will sum the total wages paid under their family and medical leave policy during the taxable year and multiply the result by 12.5% to 25% (depending on their policy’s wage replacement level). Employers claiming the paid family leave tax credit must reduce their annual tax deduction for employee compensation by the amount of the credit.
While detailed information is not required to claim the credit, employers should maintain records with identifying information on employees who take qualifying leave and the wages paid to those employees.
Note: This explainer does not constitute tax advice. Employers interested in claiming the credit may want to seek the advice of tax professionals.
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