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Legal Update

Jan 30, 2025

IRS Clarifies the Federal Income and Employment Tax Treatment of Contributions to and Benefits Paid from State Paid Family and Medical Leave Programs

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Seyfarth Synopsis: As mandatory State paid family leave and paid family and medical leave (collectively “PFML”) programs have significantly expanded and proliferated in recent years, participating employers and employees have been faced with a variety of legal, practical and administrative challenges and uncertainties. One such example involves ambiguity as to how contributions to, and benefits paid out of, PFML programs are to be reported and treated for tax purposes. Thankfully, on January 15, 2025, the Internal Revenue Service (“IRS”) released Revenue Ruling 2025-4 (the “Ruling”), which provides long-awaited and welcome guidance on this subject.  

Today, 13 States, plus Washington, D.C., have enacted a patchwork of mandatory – and in many ways inconsistent – PFML programs.  At a high level, a mandatory PFML program provides wage replacement benefits to eligible employees who are absent for a qualifying reason up to a certain number of weeks in a 52-week period. Employers can comply with a PFML mandate either through the jurisdiction’s public program or, to the extent available, a private plan option.

The three most common PFML qualifying absences include (a) the employee’s own medical-related absences due to a serious health condition (“medical”), (b) bonding with a new child (“bonding”), and (c) caring for a covered family member with a serious health condition (“caregiving”). The Ruling generally defines “medical leave” consistent with point (a) in the prior sentence. The Ruling defines “family leave” to include bonding and caregiving absences as defined in this paragraph, as well as absences related to military exigency or military caregiver leave.[1]

Qualifying absences are just one of the more than 30 substantive, technical standards, many of which have additional layers, that exist under a given mandatory PFML program. As explained below, two of the most important of these standards in the eyes of both employers and their employees – how the PFML program is funded and the amount of wage replacement paid to employees on PFML leave – are impacted by the Ruling.

Here is what you need to know:

  • Employee contributions to a mandatory PFML program, and any contributions made by an employer in place of an employee’s contributions, must be included in the employee’s Federal gross income and the employer must report these amounts on the employee’s Form W-2. These amounts are considered wages for Federal income and employment tax (i.e., social security tax, Medicare tax and Federal unemployment tax) purposes.
  • Employees who itemize deductions on their Federal income tax returns may deduct the contributions described in the prior bullet as State income taxes paid, up to the State and Local Tax (“SALT”) deduction limitation.
  • Employer contributions to a PFML program (other than employer contributions made in lieu of required employee contributions) are not included in an employee’s Federal gross income, they are not considered wages for Federal income or employment tax purposes, and they are not reported on an employee’s Form W-2.
  • Employers may deduct employer contributions and any payments that they are legally allowed and voluntarily choose to make in place of their employees’ contributions to PFML programs.
  • Family leave benefits are included in the employee’s Federal gross income. However, they are not considered wages for Federal income or employment tax purposes. States are required to report these payments on Forms 1099.
  • Medical leave benefits are included in the employee’s Federal gross income and considered sick pay and wages for Federal income and employment tax purposes only to the extent such benefits are attributable to the employer’s contributions (but excluding employer contributions in lieu of required employee contributions) to the PFML program. Medical leave benefits attributable to employee contributions, and employer contributions in lieu of required employee contributions, are not included in the employee’s Federal gross income.
  • The Ruling specifically avoids addressing the tax consequences and reporting requirements related to contributions to and benefits paid from a private plan established by an employer in lieu of a State’s PFML program.
  • The foregoing rules do not apply for tax years before 2025, so they do not impact Forms W-2 that employers are currently preparing for their employees.
  • The IRS provides helpful transition relief for 2025 that will alleviate some of the burden associated with adjusting withholding and reporting.
  • The Ruling only addresses the Federal tax consequences of contributions to and benefits received from PFML programs. The Ruling does not address State  tax consequences. Consequently, an employer will need to determine if an applicable State has issued guidance on how benefits received from the State’s PFML program should be treated for State tax purposes.

Facts and Key Holdings

Facts

The Ruling describes facts related to a PFML program in the hypothetical “State X” and then describes six scenarios. State X has a PFML program with a standard contribution rate of 1% of each employee’s weekly wages (the “Contribution Rate”). The responsibility for funding the Contribution Rate is split between the employee, who is required to pay no more than 60% of the Contribution Rate through employer withholdings from the employee’s wages (“Employee Contributions”), and the employer, who is required to pay no less than 40% directly to the State (“Employer Contributions”). The employer is permitted, but not required, to pay some or all of the Employee Contributions itself rather than withholding the Employee Contributions from an employee’s wages (an “Employer Pickup”). If an employee makes a claim under the PFML program, then the employee will receive benefits equal to 80% of his or her average weekly wages for up to 12 weeks during the application year.

Key Holdings of the Ruling

Tax Treatment and Reporting of Contributions

The Ruling holds that Employee Contributions, Employer Contributions, and Employer Pickups are treated as follows.

  • Employee Contributions withheld from an employee’s wages are included in the employee’s Federal gross income and are considered wages for Federal income and employment tax purposes. The employer must report these amounts as wages on the employee’s Form W-2.  The employee can treat the withholdings as State income tax paid during the year and can deduct those amounts if the employee itemizes deductions. However, State income taxes paid are subject to the SALT deduction cap of $10,000 per year (currently, through the end of tax year 2025).
  • Employer Contributions are not included in an employee’s Federal gross income and the employer should not report Employer Contributions as wages on the employee’s Form W-2. Employer Contributions are considered an excise tax paid by the employer and, as such, are deductible by the employer as a business expense.
  • Employer Pickups are included in an employee’s Federal gross income and are considered wages for Federal income and employment tax purposes. The employer must report these amounts as wages on the employee’s Form W-2. The employee can treat the Employer Pickups as State income taxes paid and can deduct those amounts if the employee itemizes their deductions. However, State income taxes paid are subject to the SALT deduction cap of $10,000 per year (currently, through the end of tax year 2025). From the employer’s perspective, Employer Pickups are not treated as a deductible excise tax, but they are treated as a deductible ordinary business expense.

Tax Treatment and Reporting of Benefits Payments

The Ruling holds that benefits disbursed under a PFML program are treated as follows:

  • Family leave benefits are included in the employee’s Federal gross income. However, they are not considered wages for Federal income or employment tax purposes. The paying State must issue a Form 1099 reporting the benefits paid to the employee.
  • Medical leave benefits attributable to Employer Contributions are included in an employee’s Federal gross income and are considered wages for Federal income and employment tax purposes and sick pay under Section 3402(o) of the Internal Revenue Code. However, medical leave benefits attributable to Employee Contributions and Employer Pickups are excluded from an employee’s Federal gross income and are neither wages for Federal income or employment tax purposes nor sick pay under Section 3402(o) of the Code. The Ruling only indirectly explains the implications of classifying these benefits as sick pay by a reference to Notice 2015-6. The Ruling considers a State paying medical leave benefits  under a PFML program to be a third-party payer that is not an agent of the employer. Accordingly, pursuant to Notice 2015-6, the State would not be required to withhold income tax from the medical leave benefits (unless the employee submits a Form W-4S to the State requiring that the State withhold income tax from the payments) but the State would be required to withhold the employee portion of FICA tax and, unless the State takes certain steps to transfer liability to the employer, pay Federal unemployment tax (FUTA) and the employer portion of FICA tax with respect to the medical leave benefits. Further, if a State does not take steps to transfer such liability to the employer, the State will be required to file a Form W-2 as the employer and using its own employer identification number, reporting the medical benefits paid to the employee and the taxes withheld. However, if a State does take steps to transfer the responsibility for paying FUTA and the employer portion of FICA tax with respect to medical leave benefits, the State would not need to file a Form W-2 and the employer would include the medical leave benefits and withheld taxes on the employee’s Form W-2 filed by the employer.

    We question whether States will be willing to abide by the Ruling and withhold the appropriate taxes and file Forms W-2 or, even less likely, pay the employer taxes, with respect to medical leave benefits. Perhaps they will comply with the withholding requirements but take steps to transfer the liability for the employer taxes to the actual employers. We would not be surprised to see States that intend to comply with the Ruling but not take steps to transfer employer tax liability to the actual employers increase the employer contribution rates to fund employer taxes imposed on the States.           

Notably, the IRS does not address the tax consequences or reporting of contributions or benefit payments under a private plan. In fact, the IRS includes a footnote that specifically states that it is not addressing the Federal tax treatment connected to private plans.

Examples from the Ruling

In order to help you understand the holdings of the Ruling, the following summarizes the scenarios included in the Ruling and explains what the holdings mean in the context of those scenarios:

  1. Scenario 1:  Employer has an employee who resides in State X and, for 2025, has weekly wages of $2,000 and annual wages of $104,000. As required by the State X PFML program, Employer contributes a total of $1,040 to the PFML fund with respect to the employee, $624 paid through employee withholdings (i.e., the Employee Contributions) and $416 paid directly by the employer (i.e., the Employer Contributions).
    • The Employer Contributions are deductible by the employer and is not included in the employee’s Federal gross income or reported on the employee’s Form W-2.
    • The Employee Contributions are included in the employee’s wages for Federal income and employment tax purposes and the employer must report these amounts as wages on the employee’s Form W-2. If the employee itemizes deductions the employee may deduct the Employee Contributions as State income tax paid, up to the SALT deduction cap.
  2. Scenario 2:  The same facts as Scenario 1 and, in addition, the employee takes 12 weeks of paid family leave in 2026. The employee’s  weekly wages are still $2,000, so the employee receives benefits of $1,600 ($2,000 x 80%) per week for the 12 weeks, or  $19,600 in total during 2026 (i.e., a Benefits Payout).
    • The paid family leave benefits are included in the employee’s Federal gross income, but they are not considered wages for Federal income or employment tax purposes and State X must issue a Form 1099 to the employee reporting the benefits paid.
  3. Scenario 3:  The same facts as Scenario 2, except that employee takes medical leave instead of family leave.
    • The medical leave benefits attributable to Employer Contributions are included in the employee’s Federal gross income and are considered wages for Federal income and employment tax purposes and third-party sick pay. The payments are subject to income tax withholding only if the employee so requests, and are subject to tax reporting and employment tax withholding and payment as described above under Tax Treatment and Reporting of Benefits Payments.
  4. Scenario 4:  The same facts as Scenario 1, except the employer withholds only $350 from the employee, voluntarily pays the remaining $274 of the employee’s required $624 contribution (i.e., an Employer Pickup), and pays the employer’s required contribution of $416 (for a total of $690 paid by the employer).
    • The Employer Contributions and Employer Pickup are deductible by the employer.  The Employee Contributions and Employer Pickup are included in the employee’s wages for Federal income and employment tax purposes and the employer must report these amounts as wages on the employee’s Form W-2. If the employee itemizes deductions, the employee may deduct the Employee Contributions and Employer Pickup as State income tax paid, up to the SALT deduction cap.
  5. Scenario 5:  The same facts as Scenario 2 (i.e., the employee takes paid family leave) except, as in Scenario 4, the employer withholds only $350 from the employee, voluntarily pays the remaining $274 of the employee’s required $624 contribution, and pays the  employer’s required contribution of $416 (for a total of  $690 paid by the employer).
    • The tax treatment of the paid family leave benefits is the same as the treatment described in Scenario 2.
  6. Scenario 6:  The same facts as Scenario 3 (i.e., the employee takes paid medical leave) except, as in Scenario 4, the employer withholds only $350 from the employee, voluntarily pays the remaining $274 of the employee’s required $624 contribution, and pays the  employer’s required contribution of $416 (for a total of $690 paid by the employer).
    • The Employer Pickup is not treated as an Employer Contribution and, therefore, the tax treatment of the medical leave benefits is the same as the treatment described in Scenario 3.

Transition Relief for 2025

Although the Ruling is effective as of January 1, 2025, the IRS recognized that employers and States will need time to smoothly transition to the new requirements and so has granted the following temporary relief for calendar year 2025:

  1. For medical leave benefits that are attributable to Employer Contributions, States and employers: 
    • are not required to follow the income tax withholding and reporting requirements applicable to third-party sick pay, and are not liable for any associated penalties for failing to file or furnish correct information returns; and
    • are not required to comply with employment tax withholding, payment and  reporting requirements applicable to third-party sick pay, and they are not liable for any associated penalties.
  2. Employers are not required to report Employer Pickups as wages for Federal income and employment tax purposes.

Comparison of Existing State PFML Programs

As noted above, two of the most important substantive, technical aspects of a State  mandatory PFML program are how the PFML program is funded and the wage replacement paid to employees on PFML leave. Given the impact of the IRS’ January 15 Ruling on these topics, here are some highlights and reminders about PFML funding and wage replacement standards under existing PFML programs:

  1. PFML Funding:
    •  Mandatory PFML programs are funded in one of three ways – (a) funded by both employee and employer contributions, (b) funded by only employee contributions, or (c) funded by only employer contributions.
    • Most existing PFML programs fall into group (a). These include the PFML laws in Colorado, Delaware (benefits become available 1/1/2026), Maine (benefits become available 5/1/2026), Maryland (benefits become available 7/1/2026), Massachusetts, Minnesota (benefits become available 1/1/2026), Oregon, and Washington. 
    • Several programs fall into group (b), including Connecticut PFML and the paid family leave laws in California, New Jersey, New York, and Rhode Island.
    • Only the Washington, D.C. PFML program falls into group (c) at this time.
    • Most mandatory PFML programs allow the employer to cover the employee portion of the contribution.
    • Importantly, in addition to how the program is funded, each PFML program also contains certain specific funding metrics, such as contribution rates, the percentage of the contribution for which employees/employers are responsible, a ceiling on employee contributions, and so forth. In many cases, certain of these metrics are fluid and periodically adjusted by the program.   
  2. PFML Wage Replacement
    • PFML wage replacement has several subcomponents – (a) the percentage of wage replacement, (b) the broader wage replacement formula encompassing this wage replacement percentage, which includes nuances such as how the program defines concepts like “employee average weekly wage” and “base period,” (c) potential relevant jurisdiction-specific metrics (i.e., the State average weekly wage or State minimum wage), and (d) the weekly maximum wage replacement payable to an employee.
    • The percentage of wage replacement varies among mandatory PFML programs. Putting aside Rhode Island paid family leave,[2]  PFML program wage replacement percentages range from 50% to 100% with multiple jurisdictions having a formula that includes multiple percentages (i.e., 90% wage replacement up to a certain employee earning threshold, followed by a 50% wage replacement for any additional employee earnings up to the weekly maximum wage replacement). Notably, no existing State PFML mandate other than Oregon provides 100% wage replacement benefits to employees. And even the Oregon PFML program has limits as it only provides 100% wage replacement to employees whose average weekly wage is 65% or less than the State average weekly wage.
    • As of mid-2024, the weekly maximum wage replacement payable to an employee on approved PFML leave ranged from a low mark of $941.40 in Connecticut to a high mark of $1,620 in California.[3] Similarly, in mid-2024, the Colorado, Massachusetts, New York, and Washington D.C., PFML weekly maximum wage replacements fell between $1,100 and $1,200, while the PFML weekly maximum wage replacements in Oregon and Washington fell between $1,450 and $1,525.
    • Notably and similar to certain PFML funding metrics, the PFML wage replacement weekly maximum is fluid and is periodically changed by State PFML programs, most commonly at the start of the year. For instance, in New York, the paid family leave weekly maximum wage replacement increased to $1,177.32 at the start of 2025, which is $26.16 more than the weekly maximum from 2024.

With the paid leave landscape continuing to rapidly expand and grow in complexity, we encourage companies to reach out for solutions and recommendations for addressing compliance with paid leave requirements. To stay up-to-date on paid leave developments, click here to sign up for Seyfarth’s Paid Leave mailing list. Companies interested in Seyfarth’s paid family leave laws survey should reach out to paidleave@seyfarth.com.

[1] While the Ruling’s definitions of “medical leave” and “family leave” cover the most common qualifying absences across existing mandatory State PFML programs, they do not cover all qualifying absences under these programs. Several State PFML programs permit leave for additional reasons, such as bereavement leave, safe time, bone marrow and organ donation, prenatal care, and public health emergencies.
[2] Unlike other mandatory PFML programs which typically measure the amount of wage replacement to which an employee is entitled based on the employee’s average weekly wage, the Rhode Island paid family leave law measures wage replacement based on the employee’s highest earning quarter in the “base period.” Given this distinction, the Rhode Island paid family leave wage replacement percentage is set at 4.62 percent of the wages paid to the individual in that calendar quarter.  
[3] The impending Delaware PFML program sets its initial weekly maximum wage replacement at $900 when the program begins in 2026.