New Federal Guidance for State Paid Leave Laws
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Discussion:
The Internal Revenue Service (IRS) and Department of Labor (DOL) provided guidance on issues regarding state leave laws and their interaction with federal employer and employee requirements. The guidance focuses on state and local paid family and medical leave (PFML) benefits. The key provisions are summarized below.
IRS Provides Guidance on the Tax Impact of PFML
The IRS recently released Revenue Rule 2025-4, which provides much needed guidance on federal tax treatment of state paid leave laws. Over the last several years, many states have passed mandatory paid leave laws allowing employees to continue to receive at least partial wages when they cannot work due to injury, illness, or disability to themselves or covered family members. While these state laws provided clear guidance on when and how much leave could be taken, little guidance was given on whether the payments received were taxable.
The revenue ruling addresses both the tax treatment of contributions and benefits.
Contributions
- Employer Contributions. Employers may consider mandatory contributions to a state’s paid family and medical leave fund to be excise taxes and therefore not subject to FICA, FUTA, or federal income tax.
- Employee Contributions. Employees may treat their contributions as after-tax contributions and, if an employee itemizes deductions on their personal income tax filing, deduct the amount they contribute. However, the employee deduction cannot exceed the state income tax deduction limitation.
- Employer Pick-Up. Some employers have chosen to cover both the required employee and employer contribution. The revenue ruling makes clear that employers must include employer pick-up contributions as additional compensation subject to normal employment taxes. The employee can deduct these contributions as state income tax to the extent permitted.
See Table 1 for more information.
Benefits
- Family Leave Benefits. Wage replacement benefits during leave to care for a family member with a serious health condition are income but are not reportable as wages subject to FITW, FICA, and FUTA. The IRS compared these benefits to Social Security payments that are not treated as remuneration from employment. However, the state must report the payments to the employee on Form 1099 as income subject to FIT.
- Medical Leave Benefits. Payments paid by the state are excluded from income to the extent that the coverage was paid by the employee and not the employer. The portion of the benefit that is attributable to employer contributions funded by the employer is included in the employee’s gross income, treated as wages and considered third-party sick pay in income and wages.
- The guidance includes additional examples of taxation of benefits where employee contributions have been paid by the employer for both medical and family leave benefits.
See Table 2 for more information.
As expected, the burden of correct reporting falls on the employer. Calendar year 2025 is being treated as a transition period for purposes of enforcement and administration. However, employers should review current processes as soon as possible with their tax professional, payroll, and human resource teams to make sure contributions and benefits are appropriately taxed and reported on employee W-2s. The IRS does not address the tax treatment of private plans, so employers should consult with their tax professional.
DOL Opinion Letter: FMLA Substitution Rule When Employee Receives PFML Benefits During FMLA Leave
Effective January 14, 2025, the DOL issued an Opinion Letter regarding the FMLA substitution rule when an employee on FMLA leave is also receiving state or local PFML benefits. The FMLA substitution rule addresses an employer’s or an employee’s choice in using employer-provided accrued paid leave in order to receive pay during unpaid FMLA leave. Typically, an employer can require or an employee can choose to use accrued paid leave during their unpaid FMLA leave. The accrued paid leave runs concurrently with FMLA. The rule does exclude short-term disability (STD) and workers’ compensation benefits since those benefits mean the FMLA leave is no longer unpaid. Under these circumstances, the employer and employee must both agree to use the employer-provided leave to receive full pay during FMLA.
The DOL Opinion Letter states that PFML benefits operate the same as STD and workers’ compensation benefits during FMLA leave. The substitution rule does not apply because the employee is not on unpaid leave. The employer and employee must both agree to the use of the accrued paid leave to “top up” the PFML benefits to bring the employee to full pay. Employers should review and update their leave policies and procedures in light of the Opinion Letter.
Action Items
- Review PFML contribution and benefit tax implications with a tax professional.
- Review and update FMLA policies and procedures to account for treatment of concurrent PFML benefits.
Disclaimer: This document is designed to provide general information and guidance concerning employment-related issues. It is presented with the understanding that ManagEase is not engaged in rendering any legal opinions. If a legal opinion is needed, please contact the services of your own legal adviser. © 2025 ManagEase