Claiming the New Employer Tax Credit for Family and Medical Leave

The Tax Cuts and Jobs Act (TCJA) establishes a new federal income tax credit for employers that provide qualifying paid family and medical leave benefits to their employees. This credit is only available for two employer tax years — those beginning between January 1, 2018 and December 31, 2019 — unless Congress extends the deal. Here are some FAQs about this tax break.

How Much Is the Credit?

An eligible employer can claim a credit equal to 12.5% of wages paid to qualifying employees who are on family and medical leave, if the leave payments are at least 50% of the normal wages paid to those employees. For each 1% increase over 50%, the credit rate increases by 0.25%, up to a maximum credit rate of 25%.

How is a qualifying employee defined? It's an individual who has been employed by your company for at least one year, and his or her compensation for the preceding year doesn't exceed 60% of the threshold for highly compensated employees for that year. For 2017 and 2018, the threshold for highly compensated employees is $120,000. That means a qualifying employee's 2017 compensation can't exceed $72,000 (60% x $120,000).

Employers that claim the family and medical leave credit must reduce their deductions for wages and salaries by the amount of the credit.

To illustrate how to compute the credit, suppose your company pays wages of $120,000 for its 2018 tax year to qualifying employees while they're on family and medical leave. This amount equals 50% of their normal wages. The company can claim a family and medical leave credit of $15,000 (12.5% x $120,000).

Alternatively, let's suppose your company pays wages of $180,000 to qualifying employees while they're on family and medical leave. This amount equals 75% of normal wages. In this scenario, your credit rate increases to 18.75% [12.5% + (25 x .25%)]. So, your company can claim a credit of $33,750 (18.75% x $180,000).

What Types of Leave Qualify?

For purposes of qualifying for the credit, family and medical leave is defined as leave taken by a qualified employee for any of the following reasons:

For the birth, adoption or fostering of a child (and to care for that child).
To care for a spouse, child or parent with a serious health condition.
When the employee has a serious health condition.
For any qualifying exigency due to an employee's spouse, child or parent being on covered active duty (or having been notified of an impending call or order to covered active duty) in the Armed Forces, or
To care for a spouse, child, parent or next of kin who is a covered veteran or member of the Armed Forces.

Employer-provided vacation leave, personal leave, or medical or sick leave (other than qualifying leave as defined above) isn't eligible for the credit. Also, leave that's paid by a state or local government or required by state or local law isn't eligible for the credit.

Is the Credit Subject to Any Limits?

For each employee, the maximum length of paid family and medical leave that qualifies for the credit is 12 weeks during the employer's tax year.

Additionally, the total credit for each employee for a tax year can't exceed the employee's normal hourly rate for each hour (or fraction of an hour) multiplied by the number of hours (or fractions of an hour) that family and medical leave is taken. Wages for employees who aren't paid on an hourly basis are prorated to calculate an effective hourly wage rate.

For example, Wally Workman's normal wage rate is $20 per hour. During the company's 2018 tax year, Wally takes 80 hours of family and medical leave. The company's credit for Wally's family and medical leave can't exceed $1,600 ($20 times 80 hours of leave).

Which Employers Are Eligible?

An eligible employer is any employer that has a written policy in place that meets these three requirements.

For qualifying full-time employees, at least two weeks of annual paid family and medical leave must be provided. For qualifying part-time employees, the length of leave is prorated based on the number of hours the employee usually works during a week compared to the hours a full-time employee is expected to work. A part-time employee is defined as an individual who customarily works less than 30 hours per week.
Qualifying employees on leave must be compensated at least 50% of their normal wages.
An employer that isn't covered by Title I of the Family and Medical Leave Act of 1993 (FMLA) must include in its written policy a nonretaliation statement that it won't interfere with, restrain, or deny the exercise of or the attempt to exercise, any right provided under the policy. Furthermore, the written policy must state that the employer won't discharge or discriminate against any individual for opposing any practice prohibited by the policy.

Important note: All employers treated as a single employer under the controlled group rules of Internal Revenue Code Section 52(a) and the common control rules of Code Section 52(b) are treated as a single employer for purposes of determining the family and medical leave credit.

To claim the credit for the employer's first tax year beginning after December 31, 2017, the employer's written policy must be in place before the paid family and medical leave for which the credit will be claimed is taken. So, it's a good idea to put your plan in place sooner rather than later.

When Must Your Company's Family and Medical Leave Policy Be Established?

The general rule is that to claim the credit for your company's first tax year that begins after December 31, 2017, your written family and medical leave policy must be in place before the paid family and medical leave for which the credit will be claimed is taken.

However, under a favorable transition rule for the first tax year beginning after December 31, 2017, your company's written leave policy (or an amendment to an existing leave policy) will be considered to be in place as of the effective date of the policy (or amendment) rather than the later adoption date. So if you make the effective date of the policy January 1, 2018, your company can claim the credit for qualifying family and medical leave payments made on or after that date. This transition rule is available if:

The policy or amendment is adopted by 12/31/18 and
You bring your leave practices into compliance with the terms of the retroactive policy (or amendment) for the entire period covered by the policy (or amendment), including making any retroactive leave payments by no later than the last day of the tax year.

For More Information

The new family and medical leave credit could be an attractive perk for your company's employees. However, it can be an expensive one because it must be provided to all qualifying full-time employees. In recently issued Notice 2018-71, the IRS released guidance in Q&A format on how the credit works. Consult your tax advisor if you have questions or want more information about the new credit.