Compliance Snapshot
- Employers may receive a business tax credit for providing paid family and medical leave to their qualifying employees through 2025;
- A qualifying employee is an employee who has been employed by the employer for one year or more and whose compensation for the preceding year does not exceed certain limits;
- For employers claiming a credit for wages paid to an employee in 2021, the employee must not have earned more than $78,000 in 2020.
- Employers must have a written policy that meets certain requirements in order to qualify;
- Employer paid leaves for reasons not recognized by the FMLA do not qualify for this tax credit;
- Any leave paid by a state or local government or that is otherwise required by state or local law is not considered leave provided by the employer for purposes of the tax credit (and thus will not be eligible for the tax credit);
Background
Internal Revenue Code Section 45S (IRC Section 45S) provides a business tax credit for employers who provide paid family and medical leave to their employees. The Taxpayer Certainty and Disaster Tax Relief Act of 2019 extended this credit until December 31, 2020, which has now been extended again through 2025 under the Consolidated Appropriations Act of 2021.
Certain eligible employers may claim the credit, which is equal to a percentage of wages they pay to qualifying employees while they are on family and medical leave. For more information about the mechanics of the tax credit please see IRS-Notice 2018-71 and our corresponding blog post. This article summarizes the key highlights from the guidance provided by the IRS Section 45S Frequently Asked Questions (IRS FAQs) for employers interested in structuring a paid family and medical leave policy for purposes of claiming a tax credit under IRC Section 45S. As always, employers are encouraged to consult with their tax counsel and advisors with respect to claiming employer tax credits.
IRC Section 45S Employer Credit Frequently Asked Questions
What Must be Included in an Employer’s Paid Family and Medical Leave Written Policy?
In order to comply with IRC Section 45S, an employer’s written policy must provide:
- At least two weeks (annually) of paid family and medical leave to all qualifying employees who work full time (prorated for employees who work part time), and
- The paid rate of leave cannot be less than 50 percent of the wages normally paid to the employee.
The employer must also make the leave available to all qualifying employees as defined by IRC Section 45S (even if they are not otherwise covered by the Family and Medical Leave Act (FMLA)), which means all employees who have been employed for at least one year and had compensation from the employer for the preceding year that did not exceed a certain dollar amount.
When must the Employer’s Written Policy be in Place?
An employer can claim the credit only for leave taken after their Section 45S compliant written leave policy is in place. The written policy is in place on the later of the policy’s adoption date or the policy’s effective date.
For example, if an employer adopts a written policy that satisfies all requirements of IRC Section 45S on March 10, 2021, with an effective date of March 30, 2021, the employer may claim the credit for family and medical leave paid per that policy to qualifying employees for leave taken on or after March 30, 2021.
Who is a Qualifying Employee?
A qualifying employee is an employee that meets all of the following:
- Any employee under the Fair Labor Standards Act;
- Who has been employed by the employer for one year or more; and
- The IRS FAQs state that until further guidance is issued, an employer may use “any reasonable method” to determine whether an employee has been employed for one year or more. Treating employees as employed for one year or more if they have been employed for twelve months, per the FMLA regulations, is an example of a reasonable method. However, requiring twelve consecutive months of work to be a qualifying employee is not a reasonable method for determining whether an employee has been employed for one year, as there is no requirement that the twelve months be consecutive.
- Who for the preceding year, had compensation of not more than 60% of the §414(q)(1)(B) highly compensated employee limit in the prior year (which is $130,000 for 2020).
- This means that for an employer claiming a credit for wages paid to an employee in 2021, the employee must not have earned more than $78,000 in 2020.
What are the Qualifying Reasons for Leave Covered by the Tax Credit?
For purposes of the family and medical leave tax credit, employers must provide leave for one or more of the following qualifying reasons:
- Birth of an employee’s child and to care for the child;
- 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;
- A serious health condition that makes the employee unable to perform the functions of their position;
- 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;
- To care for a service member who is the employee’s spouse, child, parent, or next of kin.
If an employer provides paid vacation leave, personal leave, or medical or sick leave (that is not limited to one or more of the qualifying FMLA-type reasons stated above), that paid leave does not qualify for purposes of the IRC Section 45S tax credit. Therefore, employers should be aware that a “general purpose” paid leave policy (such as sick leave or paid time off (PTO)) does not qualify for this tax credit.
For example, a paid leave policy that provides two weeks of “general use” paid sick leave does not satisfy the criteria, even though it may be broad enough to cover FMLA-type reasons, since the paid leave is not limited to only those reasons provided under the FMLA.
Can an Employer Claim a Tax Credit for Leave Provided Pursuant to State or Local Law?
Any leave paid by a state or local government or required by state or local law will not be taken into account in determining the amount of employer-provided paid family and medical leave.
In addition, paid leave provided pursuant to state or local requirements is not factored into determining whether an employer’s written policy includes a rate of payment of at least 50 percent of the wages normally paid to an employee. Therefore, to be eligible to claim the credit, an employer must independently satisfy the minimum paid leave requirements, including a rate of payment of at least 50 percent of wages normally paid to an employee for services done for the employer.
The IRS FAQs provide the following examples to illustrate this requirement:
Example 1
- Under state law, an employee on family and medical leave is eligible to receive six weeks of benefits paid by a state insurance fund at a rate of 50 percent of the employee’s normal wages. Additionally, the employer’s written policy concurrently allows six weeks of annual paid family and medical leave at a rate of payment of 30 percent of the employee’s normal wages for services done for the employer. So, in the aggregate, a qualifying employee can receive six weeks of annual paid family and medical leave at a rate of payment of 80 percent of the employee’s normal wages.
- Conclusion: Employer’s policy does not independently satisfy the requirement to provide a rate of payment of at least 50 percent of wages normally paid to an employee.
Example 2
- Same facts as Example 1, except that the employer’s written policy allows for each qualifying employee six weeks of annual paid family and medical leave at a rate of payment of 50 percent of the employee’s normal wages that runs concurrently with the state leave. So, in the aggregate, a qualifying employee can receive six weeks of annual paid family and medical leave at a rate of payment of 100 percent of the employee’s normal wages.
- Conclusion: Employer’s policy independently satisfies the requirement to provide for a rate of payment of at least 50 percent of wages normally paid to an employee. Only wages paid under employer’s written policy (50 percent of wages normally paid to an employee) may be used in calculating the credit. Wages paid under state law are not used in calculating the credit.
Example 3
- Under state law, employers need to allow employees six weeks of family and medical leave, and the state law permits this leave to be either paid or unpaid. Employer’s written policy allows each qualifying employee six weeks of annual paid family and medical leave at a rate of payment of 50 percent of wages normally paid to the employee.
- Conclusion: Employer’s policy independently satisfies the requirement to provide a rate of payment of at least 50 percent of wages normally paid to an employee (because the state law allows the leave to be unpaid).
How Does an Employer Claim a Tax Credit Under IRC 45S?
An eligible employer must file IRS Form 8994, Employer Credit for Paid Family and Medical Leave, and IRS Form 3800, General Business Credit, with its tax return to claim the credit.
How is the Tax Credit Calculated?
The credit is a percentage of the amount of wages paid to a qualifying employee while on family and medical leave for up to 12 weeks per taxable year. The minimum percentage is 12.5% and is increased by 0.25% for each percentage point by which the amount paid to a qualifying employee exceeds 50% of the employee’s wages, with a maximum of 25%. Employers are encouraged to discuss tax credit calculations with their tax advisors.
Additional Resources
- IRS Notice 2018-71 Employer Credit for Paid Family and Medical Leave
- Section 45S Employer Credit for Paid Family and Medical Leave – FAQs (November 2020)
- About Form 8994, Employer Credit for Paid Family and Medical Leave
- About Form 3800, General Business Credit
- Sequoia Foreword: IRS Releases Additional Guidance on the Paid Leave Tax Credit
- Sequoia Foreword: New Paid Family Leave Tax Credit
Disclaimer: This content is intended for informational purposes only and should not be construed as legal, medical or tax advice. It provides general information and is not intended to encompass all compliance and legal obligations that may be applicable. This information and any questions as to your specific circumstances should be reviewed with your respective legal counsel and/or tax advisor as we do not provide legal or tax advice. Please note that this information may be subject to change based on legislative changes. © 2021 Sequoia Benefits & Insurance Services, LLC. All Rights Reserved