IRS Provides Guidance on Employer Tax Credit for Paid Family & Medical Leave (Benefit Minute)
The Internal Revenue Service has issued Notice 2018-71, which provides guidance on the employer tax credit for paid family and medical leave. This new tax credit was established by the tax reform bill passed in December 2017 and applies to wages paid in the 2018 and 2019 tax years.
An employer need not be subject to the Family and Medical Leave Act (FMLA) to qualify for the credit. Any employer with a written policy in place that provides for family and medical leave may qualify if certain requirements are met. The employer’s written policy must provide all qualifying employees with at least two weeks of paid family and medical leave (pro-rated for part-time employees) at a rate of at least 50% of the employee’s normal wages.
If the employer is not subject to FMLA or has employees in locations that are not covered by FMLA, the written policy must include specific non-interference language.
An employer that wishes to claim the credit but does not have an appropriate written policy in place may adopt a policy retroactively as long as:
- it is adopted on or before December 31, 2018, and
- retroactive leave payments are made to bring the leave policy into compliance for the entire taxable year.
If an employer has an existing written leave policy that covers different types of leave, this may satisfy the written policy requirement. However, only paid leave specifically designated for one or more FMLA purposes qualifies for the credit.
The tax credit applies to qualifying employees, defined as any employee (whether full time, part time or other) who has been employed for one year or more and whose compensation for the preceding year is equal to or less than 60% of the qualified plan highly compensated employee definition ($120,000 in 2017 and 2018). Therefore, in order for an employee to be a qualifying employee in 2018, the employee’s prior year compensation must be $72,000 or less. Employees who do not satisfy the definition of a qualifying employee do not have to be provided paid family and medical leave.
Family and Medical Leave
An employer may claim the tax credit only if the leave is designated for one or more specific FMLA purposes and cannot be used for any other reason. For example, a written policy that provides for 6 weeks of annual paid leave for the birth and care of a newborn which cannot be used for any other reason is paid family and medical leave that qualifies for the credit.
Conversely, a paid time off policy that allows leave to be used for FMLA purposes and for other reasons such as minor illnesses, vacation or other personal time does not qualify.
Any leave paid by a state or local government or required by state or local law does not qualify for the tax credit. However, if an employer independently satisfies the minimum paid family and medical leave requirements over and above any amount provided through a program mandated by state or local law, then an employer can claim the tax credit for those amounts.
Paid leave provided under an employer’s short term disability program, whether self-insured or provided through an insurance policy, may be characterized as family and medical leave if the payments qualify as wages (i.e. taxable income to the employee) and otherwise meet the requirements. All qualifying employees must be eligible for the short term disability program. To the extent that an employer’s short term disability policy contains a pre-existing condition exclusion such that an employee who has been employed for one year or more will not be covered, the program will not qualify as paid family and medical leave unless a supplemental paid leave arrangement is available.
Calculating and Claiming the Credit
The tax credit is calculated as the “applicable percentage” of wages paid to qualifying employees during any period of family and medical leave. The applicable percentage is 12.5% when the paid leave is 50% of wages normally paid and increases by .25% for each percentage point by which the rate of leave payment exceeds 50%. The employer’s rate of payment or period of paid family leave does not have to be uniform with respect to all qualifying employees and for all FMLA purposes. However, the minimum paid family and medical leave requirements must be satisfied for all qualifying employees.
For example, a qualifying employee who is normally paid $1,000 per week takes 4 weeks of paid family and medical leave at 75% of normal pay. Payments for family and medical leave total $3,000 and the employer may claim a credit of $562.50 ($3,000*18.75%). 18.75% is calculated as the base credit rate of 12.5% plus 6.25% (25 percentage points above 50% multiplied by .25%).
For purposes of the tax credit, wages are defined as all remuneration for employment subject to the Federal Unemployment Tax Act (FUTA). Overtime (other than regularly schedule overtime) and discretionary bonuses are excluded from wages regularly paid.
Tax-exempt employers who are not subject to FUTA but have unrelated business taxable income may not claim the credit.
An employer may claim the tax credit only for family and medical leave payments made on or after the date an employee became a qualifying employee. The tax credit is available for a maximum of 12 weeks in any taxable year of the employer.
The tax credit will be claimed on IRS Form 8994, Employer Credit for Paid Family and Medical Leave and Form 3800, General Business Credit. To the extent that an employer claims the tax credit for paid family and medical leave, any available tax deduction for those wages paid is reduced by an amount equal to the credit claimed.
There is no requirement that an employer provide notice to employees regarding the written policy for paid family and medical leave. However, if an employer chooses to provide notice, it must be communicated in a manner reasonably designed to reach each qualifying employee, such as through the use of email, internal websites, employee handbooks or posted displays in employee work areas.
The Department of Treasury and the Internal Revenue Service have announced that they intend to publish proposed regulations regarding the tax credit for paid family and medical leave.