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Family and Medical Leave: Does Your Program Qualify for the Tax Credit?

by | Jan 19, 2024 | Taxes

In a tight labor market, paid family and medical leave is rapidly becoming more of an expected benefit than just a perk. The good news is the Section 45S federal tax credit for family medical leave programs can help your organization recruit and retain skilled workers while also cutting your tax bill. Here’s what you need to know about the credit and its requirements.

Sec. 45S Basics

The Sec. 45S credit was originally slated to expire after 2019, but it’s been extended through 2025. It’s available to all employers that provide paid leave under the Family and Medical Leave Act (FMLA), regardless of whether they’re subject to the law’s requirements.

However, the credit is available only for leave provided to full- and part-time employees whose wages in the preceding year didn’t exceed 60% of the so-called “highly compensated employee” threshold. For 2023, an employee’s compensation in 2022 can’t have exceeded $81,000. In addition, you must have employed the worker for at least a year.

The rate of the credit depends on how your leave pay compares with the employee’s normal wages. If the paid leave is 50% of normal wages, the tax credit is 12.5% of wages paid. The rate increases up to 25% ratably as leave pay increases from 50% of normal wages to 100%. You won’t qualify for the credit if the leave pay is less than 50% of normal wages. Additionally, you can’t claim it for leave pay that exceeds an employee’s normal wage rate. The amount of paid wages for which you claim the credit can’t exceed 12 weeks per employee per year.

Nitty-Gritty Details

When it comes to qualifying for the credit, the devil is in the details. For example, you can claim the credit only for leave taken after you’ve put in place a written family and medical leave policy — meaning the later of the adoption date or effective date. The policy must provide all qualifying employees at least two weeks of paid leave annually and can’t exclude certain classifications of employees (for example, unionized workers). The two-week period should be prorated for part-time employees.

The policy also must include FMLA protections. In other words, it must prohibit you from:

  • Interfering with, restraining or denying any right under the policy, and
  • Discharging or discriminating against any individual for opposing any practice prohibited by the policy.

The tax credit applies only to paid leave that’s specifically set aside for an FMLA-qualifying purpose. So you can’t claim it for paid vacation, personal or sick leave, even if that leave is used for an FMLA purpose.

FMLA-qualifying leave generally is leave associated with:

  • The birth of and care for a child or placement of an adopted or foster child with an employee,
  • A serious health condition of an employee or employee’s spouse, child or parent,
  • An exigency arising out of the active-duty military service of an employee’s spouse, child or parent, or
  • Caring for a covered service member who’s an employee’s spouse, child, parent or next of kin.

However, your family and medical leave policy doesn’t have to provide leave for every type of FMLA leave (unless you’re covered by the law, of course). For example, you can offer paid leave for only the birth or adoption of a child and not for the other reasons.     

You also can provide different levels of pay depending on the leave purpose. For example, you can allow 10 weeks of leave paid at 100% of normal wages for the birth or adoption of a child, but only six weeks of leave paid at 60% of normal wages for leave related to a serious health condition.

Important: If your leave program is required by state or local law, you can’t claim the credit. You also can’t claim the credit for leave paid by state or local governments.

On the other hand, family and medical leave that’s paid under your short-term disability program may qualify if it meets the requirements. That’s the case whether the program is self-insured or paid by an insurance carrier.

Additional Tax Implications

The tax credit can reduce the overall cost of your paid family and medical leave, but it has other tax effects, too. For example, you must reduce your wage and salary deduction by the amount of credit claimed. The IRS also doesn’t allow a double tax benefit — you can’t claim the credit on wages that you use to calculate another type of tax credit.

The family and medical leave credit is part of the general business credit, though, so you can carry unused credits back one year to offset that year’s tax bill or forward up to 20 years to offset future tax liability. And you can apply it against the alternative minimum tax.

Worth a Look

If you don’t already offer paid family and medical leave, the tax credit might make it worth reconsidering. If you do, take time to confirm that your policy satisfies all the requirements. Contact your tax professional to help ensure you maximize the potential tax benefits.