New two-year credit enacted as part of tax reform
The IRS released additional guidance on the employer credit for paid family and medical leave (FML), amended under the Tax Cuts and Jobs Act (P.L. 115-97), in response to practitioner questions. The IRS FAQ addresses unanswered questions around the new Section 45S general business credit, which provides employers a tax credit between 12.5 percent and 25 percent for wages paid to qualifying employees on family or medical leave paid in 2018 or 2019 calendar years. This credit creates an employer incentive to provide qualified employees at least two weeks of paid family and medical leave, paying no less that 50 percent of wages normally paid. In an effort to clarify employer credit qualification and requirements, the IRS produced this FAQ document.
Tax credit qualifications
The IRS FAQ provides guidance on how to qualify for the tax credit by defining qualified employers, qualified employees and acceptable circumstances for qualified leave. Qualified employers must have a written policy for employees that provides at least two weeks of paid FML annually for qualified employees, and no less than 50 percent of normal wages (prorated for part-time employees). The IRS further notes that a qualified employee must be employed for one year or more and does not receive compensation beyond defined limits; for 2017, an employee’s income may not exceed $72,000 to claim the 2018 credit.
Employee reasons eligible for taking this FML are broad and may include a diverse population of employees. The IRS specifically addresses the following permitted reasons for taking FML:
- 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 his or her 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
Any wages paid for leave taken outside of the above reasons will not qualify for the tax credit. The IRS also notes that any leave paid by State or local government or required by State or local law will be excluded from the tax credit calculation.
Employee wages paid through short-term disability policies have been a much debated topic around the FML tax credit. Notice 2018-71 provided clarification that FML leave provided pursuant to an employer’s short-term disability policy may be characterized as qualified leave as long as all other requirements are met. However, certain short-term disability policies may include employee requirements that exclude eligibility from the Section 45S credit; such as, excluding employees with pre-existing conditions or requiring minimum employee service of six months. To qualify for the Section 45S credit, employers with exclusive short-term disability policies may add a separate written policy to include FML paid leave for employees not qualifying under the short-term disability policy requirements.
Tax credit calculation
Once qualified paid employee family and medical leave is identified, qualified wages paid may be included for each employee while on leave for up to 12 weeks per taxable year. A minimum of 12.5% is applied to qualified wages paid and increases 0.25% for each percentage point paid to qualifying employee that exceeds 50% of the employees’ wages, to a maximum of 25%. Wage amounts deducted on the employer’s tax return must be reduced by the amount determined as a credit. In addition, wages included in other general business credits (i.e. Credit for Increasing Research Activities) must be excluded in determining this credit.
Questions still unanswered
Although the IRS FAQ is useful in identifying qualified taxpayers, the IRS recognized that this release does not answer all questions concerning written employee policy requirements, the impact of state and local requirements and controlled group credit reporting requirements.
Practitioners are hopeful the limited provision will be extended or made permanent as employers may be hesitant to adopt family leave policies to only claim a two-year benefit. Additional guidance on qualified employees and circumstances may be found in The Family and Medical Leave Act of 1993. Additional guidance from the IRS is expected to be issued in the coming months.
Taxpayers who think they might be eligible for the credit for paid family and medical leave should contact their tax advisors to ensure that all rules and requirements are met to claim the credit.