IRS provides tax guidance about state paid leave

The increase in state paid family/medical leave (PFML) laws has left both employers and employees wondering how to treat contributions and benefits for federal tax purposes. Currently, 13 states and the District of Columbia have PFML laws, and more states are considering them.

In early 2024, nine state governors got together and asked the federal IRS for guidance. The IRS responded on January 15, 2025, with Rev. Rul. 2025-04.

Contributions

State leave laws have different contribution methods, and the guidance helps illustrate their tax treatment:

• Employees may deduct their contributions as state income taxes if they itemize deductions and otherwise do not exceed the state and local tax deduction cap.
• Employees don't have to include the value of employer contributions in their compensation.
• Employers report employee contributions to a state PFML fund as taxable income and wages on Forms W-2. These are generally withheld via payroll.
• Employers can deduct their contributions as business expenses (i.e., an excise tax). Employers don't have to report it.
• If an employer voluntarily pays part of an employee's required contribution, they treat this amount as additional compensation to the employee and include it in the employee's gross taxable income and wages for federal employment tax purposes reported on a Form W-2. An employer can deduct this amount as a business expense.

Benefits

When it comes to PFML benefits, the IRS sees PFL and PML benefits differently.

PFL

• For employers that pay into a state fund, generally, the state, rather than the employer, must report the payments to the IRS and give employees a Form 1099 if they aggregate $600 or more in any taxable year.
• PFL benefit payments are fully taxable and must be included in an employee's gross income, but benefit payments are not wages for federal employment tax purposes.

PML

The IRS sees PML payments as disability payments and provides guidance that is consistent with the federal tax rules that apply to disability payments.

• Amounts paid to employees as PML benefits that are attributable to the employee's contribution (including employer pick-up of employee contributions) are excluded from the employee's gross income and are neither wages for federal employment tax purposes nor treated as sick pay.
• Amounts attributable to the employer's contribution are included in the employee's gross income and are considered wages for federal employment tax purposes. The state must follow the sick pay reporting rules attributable to third-party payments by a party that is not an agent of the employer.

Private/self-insured plans

Some PFML laws allow employers to self-insure or have a private plan. The IRS guidance doesn't address the federal tax treatment of employers' or employees' contributions to private or self-insurance PFML plans, or the amounts received by the employees as benefits under those plans.

2025 transition

The IRS is giving employers and states through 2025 to comply. It describes this as a "transition period for purposes of IRS enforcement and administration of the information reporting requirements and other rules." This gives states and employers time to configure their reporting systems and to facilitate an orderly transition.