IRS Provides Guidance for States that Require Paid Family and Medical Leave Programs
On January 16, 2025, the IRS released Revenue Ruling 2025-4 which provides guidance on the employment tax treatment of contributions and benefits paid under state paid family and medical leave (PFML) programs. Currently, 14 states and D.C. have mandatory PFML programs.
This ruling is effective for payments made on or after January 1, 2025, but there is important transition relief for 2025, discussed below.
Note: This ruling only discusses contributions and benefits of state-run programs and does not discuss the Federal tax treatment of employers’ or employees’ contributions to private or self-insurance family or medical leave plans or the amounts received by the employees as benefits under these plans.
Federal Tax Treatment of Employer and Employee Contributions
The employee’s contribution is treated as taxable wages to the employee subject to income and employment taxes and the employer reports the wages on the employee’s Form W-2. The employer’s contribution is an employer tax liability and is not treated as taxable wages to the employee or reported on the employee’s Form W-2.
Under the ruling, the IRS provides that employers may generally deduct contributions to mandatory PFML programs as a payment of excise tax. Similarly. employees may deduct contributions as income tax payments if they itemize their deductions.
Treatment of Employer Pick-up Contributions for Federal Tax Purposes
An employer pick-up contribution occurs where an employer pays from its own funds all or a portion of its employees’ otherwise mandatory contributions (as opposed to withholding such amounts from the employee’s wages).
Employers may deduct such expenses as ordinary and necessary business expenses and must include such payments in wages on employees’ Forms W-2. The ruling provides that employees are eligible for potential tax deductions for such contributions.
Federal Tax Treatment of the Benefits Paid as Family Leave
Employers may deduct such expenses as ordinary and necessary business expenses and must include such payments in wages on employees’ Forms W-2. The ruling provides that employees are eligible for potential tax deductions for such contributions. Amounts paid under these programs for family leave are taxable, but the benefits are not treated as wages subject to income and employment taxes and withholding and not reportable on Form W-2. Rather, these benefits are like social security benefits, and the state must report the payments on Form 1099.
Treatment of the Benefits Paid as Medical Leave of the Employee
Any portion of the leave benefit attributable to employee after-tax contributions will be excluded from gross income and will be treated as an amount received for accident or health insurance for personal injuries or sickness. The employee must include the portion of the leave benefit attributable to the employer contribution in gross income as wages.
The taxable portion of benefits will be treated as a third-party payment of sick pay. Under the sick pay rules, taxable medical leave paid by the state is not subject to mandatory income tax withholding. The employees can request voluntary withholding. The state is liable for the employee portion of FICA and is also liable for the employer portion of FICA and FUTA, unless the liability for the employer portion of FICA and FUTA is transferred to the employer.
Transition Relief Provided
This ruling is effective for payments made on or after January 1, 2025; but the IRS is providing transition relief from certain withholding, payment and information reporting requirements for state paid medical leave benefits paid during the 2025 calendar year.
For this purpose, calendar year 2025 will be regarded as a transition period in terms of enforcement to give states and employers time to comply with these new rules
For the year 2026 and Beyond
Employers with employees in the District of Columbia and states with mandatory PFML must make changes to their payroll or tax reporting systems. These changes must be completed before the beginning of 2026 (when the transition period expires).
For a copy of Revenue Ruling 2025-4, please click on the link below: