Federal Tax Incentives:

Paid Family and Medical Leave Credit

Background 

 

The Paid Family and Medical Leave Credit was enacted as an intended benefit to help businesses reduce their taxes while an employee is on paid leave from his or her job duties due to specified reasons was enacted as part of the Tax Cuts and Jobs Act (TCJA), P.L. 115-97.

Most businesses with at least 50 employees and most public-sector employers are subject to the Family and Medical Leave Act of 1993 (FMLA), P.L. 103-3, which requires them to provide employees, for specified reasons, up to 12 weeks during which employees retain group health benefits and after which they may return to their job. Employers that are subject to the FMLA are also required under those statutes to restore an employee to the position that he or she held prior to taking the leave or an equivalent position (29 U.S.C. §§2614(a)(1)(A) and (B)) and to maintain health benefits during the period the eligible employee is on leave (29 U.S.C. §2614(c)(1)). However, the FMLA does not require employers to pay employees any wages or salary during the leave, but some do nevertheless.

Internal Revenue Code Section 45S provides a tax credit for employers who provide paid family and medical leave to their employees. Eligible employers may claim the credit, which is equal to a percentage of wages they pay to qualifying employees while they’re on family and medical leave. Sec. 45S provides a general business credit (under Sec. 38) for employers that pay qualifying employees at least 50% of their salary while on family and medical leave for up to 12 weeks in a year.

The credit generally is effective for wages paid in taxable years of the employer beginning after December 31, 2017, and it isn’t available for wages paid in taxable years of the employer beginning after December 31, 2019. 
 

The Paid Family and Medical Leave Credit under Sec. 45S is available to eligible employers both subject to the FMLA and exempt from it, with some additional requirements in the latter case and the requirement of a written plan containing certain specified provisions in either case. For employers currently offering paid family leave, the new credit may provide an immediate benefit.

Calculating the Credit

The family and medical leave credit amount equals an applicable percentage of the amount of wages paid to qualifying employees by an eligible employer during a period of up to 12 weeks when the employees are on family and medical leave (I.R.C. §§ 45S(a)(1) and (b)(3)). The wages paid to an employee on leave must not be less than 50% of the wages normally paid to such employee for services performed for the employer (I.R.C. § 45S(c)(1)(B)).

The credit's applicable percentage is 12.5% of wages paid to qualifying employees on family and medical leave during the tax year, increased by 0.25 percentage points for each percentage point by which the wages paid for family and medical leave exceed 50% of the employees' normal wages.

  • The maximum credit is 25% (12.5% + [50% × 0.25%]) of wages paid for which leave is taken, where those wages are paid at a rate equal to 100% of an employee's normal wages (Sec. 45S(a)(2)).

    • The credit is limited to each employee's number of hours for which family and medical leave is taken, multiplied by that employee's normal hourly rate of pay when providing services to the employer (Sec. 45S(b)(1)).

    • A method for converting a non-hourly rate to hourly will be established by future IRS regulations (Sec. 45S(b)(2)). Until then, employers may use any reasonable method to convert non-hourly wages to an hourly rate (Notice 2018-71, Q&A 32).

I.R.C. § 45S(a) Establishment Of Credit & Applicable Percentage 

  • In the case of an eligible employer, the paid family and medical leave credit is an amount equal to the applicable percentage of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave.

  • The term “applicable percentage” means 12.5% increased (but not above 25 per-cent) by 0.25 percentage points for each percentage point by which the rate of payment (as described under I.R.C. § 45S(c)(1)(B)) exceeds 50%.

I.R.C. § 45S(b) Limitation

In general, the Paid Family and Medical Leave Credit with respect to any employee for any taxable year shall not exceed an amount equal to the product of the normal hourly wage rate of such employee for each hour (or fraction thereof) of actual services performed for the employer and the number of hours (or fraction thereof) for which family and medical leave is taken.

  • I.R.C. § 45S(b)(2) Non-Hourly Wage Rate — in the case of any employee who is not paid on an hourly wage rate, the wages of such employee shall be prorated to an hourly wage rate under regulations established by the Secretary.

  • I.R.C. § 45S(b)(3) Maximum Amount Of Leave Subject To Credit — The amount of family and medical leave that may be taken into account with respect to any employee for any taxable year shall not exceed 12 weeks.​​​

Until further guidance is issued, the IRS has said that, for employees paid on a basis other than salaried or at an hourly rate, employers should use the regulations under the Fair Labor Standards Act of 1938 (FLSA) to determine employees' regular rate of pay (Notice 2018-71).

Wages

"Wages" has the same meaning as under Sec. 3306(b) (without regard to any dollar limitations) purusant to I.R.C. § 45S(g). Section 3306(b) generally defines wages as all remuneration for employment, as defined by section 3306(c), subject to certain limitations.  Employers must also reduce the amount of any deduction claimed for wages and salaries paid during the year (and reduce any other wage-based general business credit component claimed) by the amount of the family and medical leave credit (Secs. 38 and 280C(a)).

In general, the term “wages” has the meaning given such term by subsection (b) of section 3306 (determined without regard to any dollar limitation contained in such section). Such term shall not include any amount taken into account for purposes of determining any other credit allowed under this subpart.

The IRS has said that "[o]vertime (other than regularly-scheduled overtime) and discretionary bonuses are excluded from wages normally paid" (Notice 2018-71, Q&A 19). Until further guidance is issued, for
employees who are paid (in whole or in part) on a basis other than a salaried or hourly rate, an employer must
determine wages normally paid to the employee using the rules for determining regular rate of pay set forth in
regulations issued under the FLSA. See 29 CFR section 778.109.

Wages Paid by Third-Party Payer 

Wages paid by a third-party payer (including an insurance company, a professional employer organization, or a Certified Professional Employer Organization) to qualifying employees for services performed for an eligible employer are considered wages for purposes of the credit. However, only the eligible employer, and not the third-party payer, can take these wages into account when figuring the credit.
 

Leave Paid by a State or Local Government or Required by a State or Local Law 

Leave paid by a state or local government or required by a state or local law isn’t taken into account when figuring the credit.

Wages Paid Through Short-Term Disability Program.
Wages paid through an employer’s short-term disability program for family and medical leave are taken into account in figuring the credit provided that the program (in combination with any other employer-paid leave arrangement) meets the minimum paid leave requirements.
 

Employee becomes a Qualifying Employee after Leave is Taken 

An eligible employer may claim the credit only with respect to wages paid to an employee who is a
qualifying employee at the time family and medical leave is taken. Wages paid to an employee for family and
medical leave before an employee becomes a qualifying employee are excluded in determining the employer’s credit.

However, if an employer’s written policy provides that employees may take paid family and medical leave before they become qualifying employees and doesn’t provide a dedicated amount of leave meeting the minimum paid leave requirements that may only be taken after an employee becomes a qualifying employee, the leave will not fail to (a) be specifically designated for an FMLA purpose, or (b) meet the minimum paid leave requirements, solely because an employee may take paid leave before becoming a qualifying employee.

Eligible Employer for Whom Qualifying Employees Perform Services.

Only an eligible employer for whom qualifying employees perform services can claim the credit with respect to wages paid.


Normal Hourly Wage Rate of an Employee Not Paid an Hourly Wage Rate 

Until further guidance is issued, an employer may use any reasonable method to convert the normal wages paid to an employee who isn’t paid an hourly wage rate to an hourly rate.

Eligible Employer: Written Policy Requirement

An employer eligible for the credit is one with a written policy in place that requires the employer to provide

  • (1) at least two weeks annually of paid family and medical leave to qualifying employees other than part-time employees (Sec. 45S(c)(1)(A)); and 

  • (2) not less than 50% of the wages normally paid to the employee(s) on leave (I.R.C. § 45S(c)(1)(B)).

    • The two-week requirement is prorated for part-time employees (those working less than 30 hours per week) by the ratio of the weekly hours they are expected to work to those of an "equivalent" full-time employee.

    • For example, the written policy would need to provide part-time employees working 25 hours a week 1.25 weeks of paid family and medical leave, if the policy offers the minimum allowable two weeks' paid leave to equivalent qualifying employees who are expected to work 40 hours a week (for an example of how this calculation works, see "Formula for Prorated Leave for a Part-Time Employee").

Non-interference Language 

If an employer is not subject to the FMLA, the employer (taxpayer) may be still be eligible to claim the credit if the employer’s policy meets the requirements described below. 

 

A special rule applies under Sec. 45S(c)(2) to "added" employers and "added" employees under Sec. 45S, meaning qualifying employees who are not subject to Title I of the FMLA and eligible employers that offer paid family and medical leave to added employees (whether or not the employer is subject to Title I of the FMLA). An added employer's written leave plan must ensure that the employer will not interfere with, restrain, or deny an employee's exercise or attempt to exercise his or her rights under the policy, as well as not discharge or discriminate against any individual "for opposing any practice prohibited by the policy" (Sec. 45S(c)(2)(A)).

As such if the employer employs any qualifying employees who aren’t covered by title I of the Family and Medical Leave Act (FMLA), the employer’s written policy must include “non-interference” language.

If an employer employs at least one qualifying employee who isn’t covered by title I of the FMLA (including any employee who isn’t covered by title I of the FMLA because he or she works less than 1,250 hours per year), the employer must include “non-interference” language in its written policy and comply with this language to be an eligible employer. This requirement applies to:

  • An employer subject to title I of the FMLA that has at least one qualifying employee who isn’t covered by title I of the FMLA, and

  • An employer not subject to title I of the FMLA (that has no employees covered by title I of the FMLA).

The “non-interference” language must ensure that the employer will not interfere with, restrain, or deny the
exercise of or the attempt to exercise, any right provided under the policy, and will not discharge, or in any other manner discriminate against any individual for opposing any practice prohibited by the policy.

The following “non-interference” language is an example of a written provision that would satisfy this requirement:

  • [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.

 

Written Policy Documentary Requirements

An eligible employer’s written policy may be set forth in a single document or in multiple documents. For example, an employer may maintain different documents to cover different classifications of employees or different types of leave, and those documents collectively will constitute the employer’s written policy. An eligible employer’s written policy also may be included in the same document that governs the employer’s other leave policies.
 

Written Policy in Place

In general, an employer can claim the credit only for leave taken after the written leave policy is in place. The written policy is in place on the later of the policy’s (1) adoption date or (2) effective date.

However, for an employer’s first taxable year beginning after December 31, 2017, a written leave policy (whether new or amended) will be in place as of the effective date of the policy or amendment, rather than a later adoption date, if the employer:

  • Adopted the policy or amendment on or before December 31, 2018, and

  • Brings its leave practices into compliance with the terms of the retroactive policy or amendment for the entire period it covers, including making any retroactive leave payments no later than the last day of the employer's taxable year. (See Notice 2018-71, Q&A 6).

Providing Notice of Written Policy to Employees.

Employers aren’t required to provide notice of the written policy to qualifying employees to claim the credit.
However, if an employer chooses to provide notice of the written policy to qualifying employees, the policy will not be considered to provide for paid leave to all qualifying employees, unless the availability of paid leave is
communicated to employees in a manner reasonably designed to reach each qualifying employee. This may
include, for example, email communications, use of Internet websites, employee handbooks, or posted displays in employee work areas.

QUALIFYING EMPLOYEE

A qualifying employee purusant to I.R.C. § 45S(d) is an employee (as defined in section 3(e) of the Fair Labor Standards Act of 1938 (FLSA), as amended) who

  • (1) has been employed by the employer for 1 year or more (I.R.C. § 45S(d)(1)); and 

    • Title I of the FMLA also applies to employees employed for at least 12 months and does not require the period to be consecutive (29 U.S.C. §2611(2)(A)(i)). The IRS has said that, until further guidance is issued, employers may use any reasonable method to determine whether an employee has been employed for one year or more, but a requirement that an employee work 12 consecutive months to qualify would not be a reasonable method (Notice 2018-71, Q&A 13).

    • Also, although under the FMLA, the employee must have worked at least 1,250 hours in the 12 months preceding the start of family and medical leave (29 U.S.C. §2611(2)(A)(ii)), the IRS has stated that Sec. 45S does not require an employee to work a minimum number of hours per year to be a qualifying employee (Notice 2018-71, Q&A 14).​

  • (2) not be considered a highly compensated employee (i.e. compensation for the preceding year doesn’t exceed an amount equal to 60% of the amount applicable for that year under section 414(q)(1)(B)(i)). (I.R.C. § 45S(d)(2))

    • A highly compensated employee is any employee paid more than the following for 2018 & 2019 tax years and thus not a qualifying employee for purposes of the credit (see IRS 2019 Instructions for Form 8994 link):

      • For 2018, the applicable amount of compensation under section 414(q)(1)(B)(i) is $120,000. Accordingly, to be a qualifying employee in 2019, an employee must have earned no more than $72,000 (60% of $120,000) in compensation in the preceding year.

      • For 2019, the applicable amount of compensation under section 414(q)(1)(B)(i) is $125,000. Accordingly, to be a qualifying employee in 2020, an employee must have earned no more than $75,000 (60% of $125,000) in compensation in the preceding year.

For this purpose, an employer whose tax year isn’t the calendar year can choose to use as the preceding year
either: (1) the employer’s immediately preceding fiscal year, or (2) the calendar year ending in the employer’s immediately preceding fiscal year. An employee’s compensation is determined under section 415(c)(3).

FAMILY AND MEDICAL LEAVE

Family and medical leave generally means leave for any one or more FMLA purposes (as defined below).
However, if an employer provides paid leave as vacation leave, personal leave, or medical or sick leave (other than leave specifically for one or more of the FMLA purposes), that paid leave isn’t considered family and medical leave.

Taxpayers must determine what counts as family and medical leave to ascertain whether an employer's leave policy meets the two- and 12-week requirements. Family and medical leave has the same definition as under FMLA Sections 102(a)(1)(A)−(E) and (3) (Sec. 45S(e)(1)).

 

As such, leave can be claimed for any of the following reasons (see also Notice 2018-71, Q&A 8).

  • The birth and care of a newborn child of the employee;

  • The placement of a child with the employee for adoption or foster care;

  • To care for the employee's spouse, child, or parent who has a serious health condition;

  • The employee's inability to perform the functions of his or her position due to a serious health condition;

  • Qualifying "exigency" arising from the employee's spouse, child, or parent is on "covered active duty" or "has been notified of an impending call or order to covered active duty" in the armed forces (including National Guard and Reserves); or

  • For a qualifying employee who is the spouse, child, parent, or next of kin of a covered servicemember, to care for the servicemember.

  • Although FMLA Section 102(d)(2) allows eligible employees to elect, or employers to require, that they substitute for family and medical leave any accrued vacation, personal, or medical or sick leave, those types of leave do not qualify for the tax credit unless restricted to one or more of the above family and medical leave purposes (Sec. 45S(e)(2)). Any leave paid or required to be paid by a state or local government will also not be taken into account (Sec. 45S(c)(4)).

Leave Specifically Designated for FMLA Purposes
Other than paid leave to care for additional individuals, paid leave made available to an employee is considered family and medical leave only if the leave is specifically designated for one or more FMLA purposes, may not be used for any other reason, and is not paid by a state or local government or required by state or local law

Leave to Care for Additional Individuals 

An employer’s written policy may provide paid leave that otherwise would be specifically designated for an FMLA purpose (for example, to care for a spouse, child, or parent who has a serious medical condition), except for the fact that the leave is available to care for additional individuals not specified in the FMLA (for example, a grandchild or grandparent who has a serious medical condition). In this limited circumstance, the fact that the leave could also be used to care for additional individuals for whom care under the FMLA purpose isn’t required doesn’t prevent the leave from being considered specifically designated for an FMLA purpose. However, the employer can’t claim the credit for any leave taken to care for an individual other than a qualifying employee’s spouse, parent, or child.

Leave Provided by Employer’s Short-Term Disability Program 

Paid leave provided under an employer’s short-term disability program, whether self-insured by an employer or provided through a short-term disability insurance policy, may be characterized as family and medical leave if it otherwise meets the requirements to be family and medical leave.

Minimum Paid Leave Requirements
For an employer to be eligible to claim the credit, the employer’s written policy must meet certain minimum
requirements with respect to paid family and medical leave. These requirements are:

  • The policy must provide at least 2 weeks of annual paid family and medical leave to all qualifying employees who aren’t part-time employees, and at least a proportionate amount of paid family and medical leave to qualifying employees who are part-time employees;

  • The policy must require a rate of payment that isn’t less than 50% of the wages normally paid to the qualifying employee for services performed for the employer; and

  • If the employer employs one or more qualifying employees who aren’t covered by title I of the FMLA, the employer’s written policy also must include the “noninterference” language discussed earlier.

Any leave that is paid by a state or local government or required by state or local law isn’t taken into account for any purpose in determining the amount of paid family and medical leave provided by the employer.
 

Minimum Period of Leave Requirement
An employer’s written policy must provide qualifying employees who aren’t part-time employees with at least 2
weeks of annual paid family and medical leave and must provide at least a proportionate amount of annual paid family and medical leave to qualifying employees who are part-time employees. For part-time employees, the paid leave ratio must be at least equal to the ratio of the expected weekly hours worked by a qualifying employee who is a part-time employee to the expected weekly hours worked by an equivalent qualifying employee who isn’t a part-time employee. In determining the amount of paid family and medical leave provided by the employer, any leave paid by a state or local government or required by state or local law isn’t taken into account.

Part-time Employees 

A part-time employee is an employee who is customarily employed for fewer than 30 hours per week. Until further guidance is issued, an employer may use any reasonable method to determine how many hours an employee customarily works per week for the employer.

 

Reasonable methods include the methods set forth in 29 CFR section 2530.200b-2 for calculating hours of service in connection with certain plans, such as qualified pension plans, subject to the Employee Retirement Income Security Act of 1974, as amended.

 

Minimum Rate of Payment Requirement
The employer’s written policy must provide that each qualifying employee who is on paid family and medical
leave will be paid at least 50% of the wages normally paid to the employee for services performed for the employer.

 

In determining the rate of payment under the policy, leave paid by a state or local government or required under state or local law isn’t taken into account.
 

Wages normally Paid to an Employee 

Wages normally paid to an employee means the wages normally paid to the employee for services performed for the employer. Overtime (other than regularly scheduled overtime) and discretionary bonuses are excluded from wages normally paid. Until further guidance is issued, for employees who are paid (in whole or in part) on a basis other than a salaried or hourly rate, an employer must determine wages normally paid to the employee using the rules for determining regular rate of pay set forth in regulations issued under the FLSA. See 29 CFR section 778.109.
 

Leave paid by a state or local government or required by state or local law.

Leave paid by a state or local government or required by state or local law isn’t taken into account in determining whether an employer’s written policy provides a rate of payment of at least 50% of the wages normally paid to an employee for services performed for the employer.

 

To be eligible to claim the credit, an employer must independently satisfy the minimum paid leave requirements, including providing a rate of payment of at least 50% of wages normally paid to an employee

Rate of Payment or Period Not Required To Be Uniform
An employer’s rate of payment or period of paid family and medical leave isn’t required to be uniform with respect to all qualifying employees and for all FMLA purposes. However, to the extent an employer’s policy provides different rates of payment or periods of paid family and medical leave for different FMLA purposes, the minimum paid leave requirements must be satisfied with respect to each FMLA purpose for which the employer intends to claim the credit.

 

Conversely, if an employer’s policy provides a uniform rate of payment and period of paid
family and medical leave for all qualifying employees and for all FMLA purposes (or a uniform rate of payment and period for several specified FMLA purposes), the policy as a whole must satisfy the minimum paid leave
requirements, and it isn’t necessary for the minimum paid leave requirements to be satisfied separately with respect to each FMLA purpose.

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