Paid Family and Medical Leave Tax Credit: What Employers Need to Know

Paying an employee who's out for a new baby, a surgery, or a parent's serious illness adds real cost to your payroll. Federal tax law offers a way to offset part of it: the paid family and medical leave tax credit under Internal Revenue Code Section 45S.

The credit is now permanent, and 2026 changes make it easier to claim. It isn't automatic, though. Eligibility depends on your written policy, your employees, the type of leave you pay for, and how you calculate the credit. This guide explains those rules using current IRS and Treasury guidance.

What Is the Paid Family and Medical Leave Tax Credit?

The paid family and medical leave tax credit is a federal general business credit for employers that pay qualifying employees while they take family or medical leave. It equals a percentage of the leave wages you pay or, starting in 2026, of qualifying insurance premiums.

Congress created the Section 45S tax credit in 2017 as a temporary incentive and extended it through 2025. The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, made it permanent.

It is a paid family leave tax credit for employers of any size, but only for leave that meets the tax rules. Older articles can mislead: even the IRS's Section 45S FAQ page warns that it doesn't yet reflect the 2026 changes.

How Does the Section 45S Tax Credit Work?

The credit rewards you for paying eligible employees during qualifying leave, for up to 12 weeks per employee each year, at a rate of 12.5% to 25%. Four pieces have to line up:

• Employer eligibility: a written policy that meets the statute's minimums.
• Eligible employees: only qualifying employees count.
• Qualifying leave: leave designated for specific family and medical purposes.
• Qualifying wages or premiums: wages are those subject to FUTA, without the $7,000 wage cap. Premiums count only to the extent they fund creditable coverage.

You can use the wage method or, if you carry a paid-leave insurance policy, the premium method. Mixing methods is allowed, but not for the same leave. The result is an income tax credit, not a payroll tax reduction.

Who Qualifies for the Paid Family Leave Tax Credit?

Not every employer or employee qualifies automatically. Start with your written policy. It must give qualifying full-time employees at least two weeks of paid family and medical leave a year (prorated for part-timers) at no less than 50% of normal wages. If any qualifying employees aren't covered by Title I of the FMLA, the policy also needs non-interference language. Since 2026, leave required or paid by a state or local government counts toward this minimum, but not toward the credit amount.

A qualifying employee, for 2026, generally:

• Is a Fair Labor Standards Act employee with one year of service, or six months if you elect the shorter period
• Customarily works at least 20 hours a week
• Earned no more than 60% of the section 414(q) highly compensated threshold the prior year (the IRS lists $96,000 for 2026)

Timing matters too: you can generally claim the credit only for leave taken after the written policy is in place.

What Types of Leave Can Qualify?

Qualifying leave is paid leave specifically designated for one or more FMLA purposes and usable for no other reason:

• Birth of a child and bonding time
• Adoption or foster placement
• Caring for a spouse, child, or parent with a serious health condition
• The employee's own serious health condition
• Certain military exigencies and military caregiver leave

Ordinary PTO, vacation, and general sick leave don't qualify. IRS guidance gives the example of a policy allowing leave for FMLA reasons, minor illness, vacation, or personal matters. That policy fails, even if an employee uses the time for a new baby. If your policy also covers a grandparent or domestic partner, you can't claim the credit for that leave.

How Much Is the Paid Family and Medical Leave Tax Credit?

The credit is 12.5% to 25% of qualifying leave wages, for up to 12 weeks per employee per year. The rate starts at 12.5% when your policy pays 50% of normal wages. It rises 0.25 percentage points for each point above 50%, topping out at 25% at full pay.

Hypothetical example: An employee normally earns $1,200 a week. Your policy pays 60%, or $720 a week, and she takes six weeks of qualifying leave. Leave wages total $4,320. Sixty percent is 10 points above the minimum, so the rate is 15%. The credit is $648.

You must reduce your deduction for wages (or premiums, under the premium method) by the credit amount.

Can Small Businesses Claim the Paid Family Leave Tax Credit?

Yes, if the business meets the same requirements as everyone else. The statute has no minimum employer size, and the IRS has said employers not covered by the FMLA can qualify if their policy meets the rules. Small size alone doesn't create eligibility.

Example: A 14-person design firm adopts a written policy giving every eligible employee four weeks of paid parental and medical leave at 60% of pay. An employee with eight months of service counts only if the firm elected the six-month threshold. Also, the credit is nonrefundable, so a firm with little income tax liability may not benefit right away. Unused general business credits can generally be carried to other years.

Is the Paid Family and Medical Leave Tax Credit Permanent?

Yes. Under current law, Section 45S is permanent for tax years beginning after December 31, 2025. Before that, it was temporary, covering 2018 through 2025. The OBBBA removed the expiration date.

On August 5, 2026, Treasury and the IRS issued Notice 2026-28, interim guidance on the premium method that employers may rely on for tax years beginning after 2025 until proposed regulations arrive. Permanent doesn't mean frozen. Regulations are still coming; 2025 and earlier years follow the older rules, including a one-year service requirement and no premium method. Confirm the rules for your specific tax year before you file.

How Do Employers Claim the Section 45S Credit?

Employers claim the credit on Form 8994, which feeds Form 3800, General Business Credit, on the income tax return. Partnerships and S corporations file Form 8994 and pass the credit through. The practical steps:

1. Determine eligibility for the tax year.
2. Review your written policy against the requirements, and amend it before leave begins.
3. Identify qualifying leave and qualifying employees.
4. Calculate the credit under the wage method, the premium method, or both, but never for the same leave. Allocate blended insurance premiums using a reasonable, documented method.
5. Maintain supporting records.
6. Complete Form 8994 and Form 3800 with your return. The Form 8994 posted on IRS.gov as of this writing predates the 2026 changes, so check for updates first. You can generally claim or decline the credit within three years of the return's due date.
7. Retain your documentation.

What Records Should Employers Keep?

Keep records that show how you reached the number:

• The written paid-leave policy, with adoption and effective dates
• Employee hire dates, weekly hours, and prior-year compensation
• Leave dates and the qualifying reason
• Payroll records showing normal wages and leave wages paid
• Credit calculations, including the rate of payment and 12-week tracking
• Insurance policies, premium invoices, and your allocation method
• Filed Form 8994 and Form 3800 with workpapers

The IRS guidance reviewed here sets no special retention period for this credit, so ask your tax advisor how long to keep them.

Section 45S vs. FMLA: What's the Difference?

FMLA is a Department of Labor employment law. Section 45S is a federal tax credit. FMLA generally provides unpaid, job-protected leave and applies to private employers with 50 or more employees. Section 45S has no size test and rewards employers that pay for qualifying leave.

Complying with FMLA doesn't establish Section 45S eligibility. You still need a written policy, paid leave designated for qualifying purposes, and qualifying employees. Job protection and pay are different things, and you can offer one without the other. State paid family leave programs are a separate matter, and the credit doesn't change your payroll tax obligations.

What Employers Should Check	Why It Matters
Employer eligibility	Determines whether the employer may qualify
Employee eligibility	Not every employee necessarily qualifies.
Written leave policy	Specific policy requirements may apply.
Qualifying leave	Only qualifying family and medical leave counts
Qualifying wages	The credit calculation depends on eligible wage amounts
Tax-year availability	Current law determines whether the credit is available.
Documentation	Records support the credit calculation and claim

Frequently Asked Questions

What is the paid family and medical leave tax credit?

It is a federal general business credit under Section 45S that lets eligible employers claim a percentage of wages, or qualifying insurance premiums, tied to paid family and medical leave. It applies only when the policy, employees, and leave all meet IRS requirements.

Who qualifies for the paid family leave tax credit?

Employers with a written policy offering at least two weeks of annual paid leave at 50% or more of normal wages may qualify. Employees generally need six months or one year of service, 20 weekly hours, and prior-year pay under the IRS limit. Providing paid leave alone isn't enough.

How does the Section 45S tax credit work?

You adopt a compliant written policy, pay qualifying employees for qualifying leave, and calculate a percentage of those wages or, starting in 2026, qualifying premiums. You claim the result on Form 8994 and the general business credit. It reduces income tax, not payroll tax.

How much is the paid family leave tax credit?

The credit ranges from 12.5% to 25% of qualifying leave wages, for up to 12 weeks per employee each year. Paying 50% of wages earns 12.5%, and each additional point of pay adds 0.25 points until 25% at full pay. Your actual amount depends on wages and eligibility.

Can small businesses claim the paid family leave tax credit?

Yes. The statute has no minimum employer size. A small business still needs a qualifying written policy, qualifying employees, and qualifying leave. Because the credit is nonrefundable, businesses with little federal income tax liability may not use it right away.

Is the paid family and medical leave tax credit permanent?

Yes. The OBBBA made the paid family and medical leave tax credit permanent for tax years beginning after December 31, 2025. The rules have changed, and regulations are still coming, so employers should verify current requirements for each tax year.

How do employers claim the Section 45S credit?

Eligible employers figure the credit on Form 8994 and carry it to Form 3800 with their income tax return. Partnerships and S corporations pass it through to owners. Check IRS.gov for any form revisions reflecting the 2026 changes before filing.

Need a Second Set of Eyes?

Whether a paid leave credit fits your business, it touches your tax return, payroll records, and books. If you'd like help reviewing your situation, TaxProNext's taxation, payroll, accounting and bookkeeping, and business consulting teams can walk through it with you. Contact TaxProNext to start the conversation.