How Beneficial is the New Paid Leave Tax Credit?
The Family and Medical Leave Act (FMLA) already requires covered employers to allow eligible employees to take up to 12 weeks of unpaid leave. But in an effort to encourage employers to offer paid leave, the recent Tax Cuts and Jobs Act of 2018 sweetened the deal by promising a tax credit to employers, starting in 2018, on the wages that they pay to eligible employees during family and medical leave. However, there are certain restrictions in the law which minimize its benefit to employers.
What counts as “family and medical leave” for tax credit purposes?
The types of leave which qualify for the tax credit are taken from the FMLA:
- Birth of the employee’s child
- Placement of a child with the employee for adoption or foster care
- Care of a spouse, child, or parent with a serious health condition
- A serious health condition which prevents the employee from performing the functions of their position
- A spouse, child, or parent on covered, active duty in the Armed Forces
- Care for a service member who is the employee’s spouse, child, or next-of-kin
The paid leave, for tax credit purposes, must be due to taking an FMLA leave. In other words, pay during the leave due to vacation, personal leave, or a medical leave is not considered for credit purposes unless it is specifically for one of above purposes. For example, if an employer provides a self-funded short-term disability benefit (which is typically due to a serious health condition which prevents the employee from performing the functions of his or her job), that wage replacement may be considered. However, any paid leave required under state or local law is disregarded for purposes of the federal tax credit. Another example of paid leave eligible for the credit would be paid parental leave in the event of a new child (as long as the paid leave wasn’t mandated under state or local law).
How an employer qualifies for the tax credit
The following requirements must be satisfied to claim the credit:
- The employer must have a written policy, allowing for at least two weeks of annual paid family and medical leave for full-time employees, or a prorated amount for part-time employees;
- The employee must have been employed by the business for at least one year;
- The employer must pay at least 50% of an employee’s normal wages while the employee is on leave; and
- For the prior year, the employee must not have earned more than 60% of the dollar threshold for being considered a highly compensated employee for 401(k) purposes (e.g., couldn’t have earned more than $72,000 in 2017 in order for the employer to claim a credit in 2018).
Even employers not subject to FMLA (e.g., have fewer than 50 employees) may still qualify for the tax credit. In order to do so, these employers must provide paid family and medical leave in compliance with a written policy which includes assurances that the employer will not interfere with an employee’s right to claim paid leave under the policy or discriminate against an employee in connection with the employer’s paid leave policy.
How the tax credit works
The tax credit is calculated as a percentage of the wages paid to an employee while on family or medical leave. If the criteria are met, the employer may claim 12.5% of those wages paid as a federal tax credit for up to 12 weeks of paid leave per year. Additionally, for every percentage-point increase in pay rate over 50% of the employee’s normal wages, the tax credit increases by 0.25%, with a maximum credit of 25% of wages paid during the leave. Take a simplified example: say an employee normally earns a wage of $1,000/week and the employer pays the employee $600/week for four weeks while on leave to care for a spouse with a serious health condition: 60% of normal wages would yield a 15% tax credit on those wages (12.5% + 0.25 x 10% = 15%), which is a $360 credit for $2,400 in wages.
It is worth noting that employers must reduce their deduction for wages by the amount of the credit. And any wages that are used in calculating another business tax credit cannot be used when calculating this credit.
But is it right for my business?
Employers who already provide paid FMLA leave for their employees, or have already been considering it, may take advantage of this tax benefit with little added difficulty. (Obviously tax-exempt employers cannot take advantage of the tax credit.) On the other hand, employers may find the incentive to be too small to offset the expense of paid leave. In any case, the provision is set to expire at the end of 2019. Unless Congress extends it, employers will only be able to take advantage of this benefit for two years.
The IRS has said that it will likely give more specific guidance on how the credit will work in the near future. If you have any questions or are interested in updating your policies to qualify for the paid leave tax credit, please contact any member of the Employee Benefits Practice Group.
**This client alert was co-authored by Jonathan Snavely, a Summer Associate working with Miller Johnson’s Employee Benefits & Executive Compensation practice. **