The IRS has recently issued guidance on the federal tax treatment of Paid Family and Medical Leave (PFML) contributions and benefits, an area where no formal guidance previously existed. In recent years, multiple states have enacted PFML programs to provide wage replacement benefits to employees who need time off due to their own medical conditions or to care for a family member. As these laws evolve, it is crucial for employers to understand the federal tax implications of PFML contributions and benefits.
Employer and Employee Contributions: Tax Implications
PFML programs typically require contributions from both employers and employees, often as a percentage of wages. Some states allow employers to cover the employee’s share of contributions, known as an “employer pick-up.”
Employee Contributions
- Tax Deduction – Employee contributions, withheld from wages, are treated as state income taxes and may be deductible under IRC §164(a)(3) if the employee itemizes deductions.
- Income Taxation – These contributions are included in the employee’s gross income and wages for federal employment tax purposes.
Employer Contributions
- Tax Deduction – Employer contributions are treated as state excise taxes and are deductible under IRC §164(a).
- Income Taxation – Employer contributions are not included in the employee’s gross income.
Employer Pick-Up of Employee Contributions
If an employer voluntarily pays part or all of an employee’s mandatory contribution, the amount covered by the employer is considered additional compensation under §61 and is included in the employee’s gross income and wages for federal employment tax purposes. The employer may deduct this amount as a business expense under §162.
Federal Income Tax Treatment of PFML Benefits
PFML benefits are subject to federal taxation depending on their classification:
Family Leave Benefits
- Taxable Income – Family leave benefits paid to employees are included in gross income but are not considered wages for federal employment tax purposes.
- Reporting Requirements – If payments total $600 or more in a taxable year, the state must report them on Form 1099.
Medical Leave Benefits
- Exclusion from Income – Benefits attributable to employee contributions (including employer pick-ups) are excluded from income under §104(a)(3).
- Taxable Component – Benefits attributable to employer contributions are included in gross income and treated as wages for federal employment tax purposes.
- Reporting Requirements – States must follow sick pay reporting rules applicable to third-party payments.
Transition Period for IRS Compliance
Recognizing the complexity of PFML tax compliance, the IRS has designated calendar year 2025 as a transition period. During this time, enforcement and administration of PFML-related reporting requirements will be adjusted to allow states and employers time to refine their compliance processes.
Next Steps for Employers
As states continue implementing PFML programs, employers must stay proactive in managing tax responsibilities and reporting requirements to avoid compliance issues. To ensure proper tax treatment and compliance, employers should:
- Review Payroll Practices – Ensure correct withholding and remittance of both employer and employee PFML contributions.
- Understand Tax Reporting Obligations – Be prepared to issue Forms W-2 and 1099 as necessary.
- Educate Employees – Inform employees about how PFML contributions and benefits impact their taxable income.
- Monitor IRS and State Guidance – Stay updated on changes to PFML taxation policies and reporting requirements.
- Seek Professional Guidance – Consult tax professionals or legal advisors to ensure compliance with federal and state PFML laws.
