The Internal Revenue Service (IRS) has released new guidance on the federal income and employment tax treatment of contributions and benefits paid under state paid family and medical leave (PFML) statutes. This guidance also outlines the related reporting requirements for employers and employees. There was no published guidance that addressed the taxation or reporting requirements of state PFML statutes before the publishing of Revenue Ruling 2025-4.
Quick Hits
- The IRS has clarified the tax treatment of mandatory employee and employer contributions to state PFML funds, as well as optional employer payment of mandatory employee contributions.
- Employers can deduct their contributions as business expenses, while employees may deduct their contributions as state income taxes if they itemize deductions and otherwise do not exceed the SALT deduction cap.
- Amounts paid to employees as family leave benefits are included in the employee’s gross income but are not wages for federal employment tax purposes.
- Amounts paid to employees as medical leave benefits align with Internal Revenue Code § 104(a)(3), which are only taxable in instances where contributions were not included in the employee’s gross income or paid by the employee.
- The IRS has provided a transition period for enforcement and administration of these rules for calendar year 2025.
Background
Over recent years, a number of states have enacted PFML statutes to provide wage replacement to workers for periods in which they need to take time off from work due to their own nonoccupational injuries, illnesses, or medical conditions, or to care for a family member due to the family member’s serious health condition or other prescribed circumstance. Many PFML statutes require contributions from both the employer and the employee, with some allowing the employer to cover the employee’s mandatory contribution rather than withholding the amounts from wages (“employer pick-up”).
Federal Income Tax Treatment of Contributions
Employee Contributions
Mandatory employee contributions withheld from wages are treated as state income taxes and are deductible under § 164(a)(3) if the employee itemizes deductions and the deductions are subject to the state and local taxes (SALT) deduction limitation under § 164(b)(6). These amounts are included in the employee’s gross income and wages for federal employment tax purposes.
Employer Contributions
Mandatory employer contributions are treated as state excise taxes and are deductible by the employer under § 164(a). These amounts are not included in the employee’s gross income.
Employer Pick-Up of Employee Contributions
If an employer voluntarily pays part of the employee’s required contribution, this amount is treated as additional compensation to the employee under § 61 and is included in the employee’s gross income and wages for federal employment tax purposes. The employer can deduct this amount as a business expense under § 162.
Federal Income Tax Treatment of Benefits
Family Leave Benefits
Amounts paid to employees as family leave benefits are included in the employee’s gross income but are not wages for federal employment tax purposes. The state must report these payments on Form 1099 if they aggregate $600 or more in any taxable year.
Medical Leave Benefits
Amounts paid to employees as medical leave benefits that are attributable to the employee’s contribution (including employer pick-up of employee contributions) are excluded from the employee’s gross income under § 104(a)(3) and are neither wages for federal employment tax purposes nor treated as sick pay. However, to qualify for medical leave benefits under a PFML statute, the time off from work must relate to the employee’s own serious health condition. Further, 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.
Transition Period for Enforcement and Administration
The IRS has designated calendar year 2025 as a transition period for the enforcement and administration of the information reporting requirements and other rules described in the guidance. This transition period is intended to provide states and employers time to configure their reporting and other systems.
