Paid Family and Medical Leave Credit (Section 45S) for Employers

The paid family leave tax credit, section 45S, pays an employer back for part of what it spends when employees take leave for a birth, an adoption, a family member's serious illness or their own. It was a temporary credit from 2018, extended twice and due to expire after 2025. P.L. 119-21, signed July 4, 2025, made it permanent and rewrote several of its rules for tax years beginning after December 31, 2025. This guide follows the statute as amended, section 45S, with the Form 8994 instructions (Rev. December 2024) for the dollar figures and mechanics. Two cautions: those instructions and the IRS section 45S FAQ page were written for the old rules, and the FAQ page carries a notice that the 2025 changes are not yet reflected. Where they differ from the statute below, the statute governs for 2026.

Two ways to figure the credit: leave wages or insurance premiums

Under section 45S(a)(1), the employer elects one of two bases. The first, and the only one before 2026, is the applicable percentage of the wages paid to qualifying employees for periods when they are on family and medical leave. The second, new for tax years beginning after 2025, is the applicable percentage of the premiums the employer paid or incurred during the year for an insurance policy that provides paid family and medical leave and is in force during the year. For the premium route, section 45S(a)(3) says the policy's rate of payment sets the percentage whether or not any qualifying employee actually took leave that year, which turns the credit into a subsidy for carrying the coverage.

The applicable percentage is the same either way: 12.5%, increased by 0.25 percentage point for each point by which the policy's rate of payment exceeds 50% of normal wages, but not above 25%.

Two limits apply on the wage route. Section 45S(b)(1) caps the wages counted for an employee at their normal hourly rate (salaried pay is prorated to an hourly rate) times the hours of leave taken, and section 45S(b)(3) counts no more than 12 weeks of leave per employee per year. Wages carry the FUTA definition in section 3306(b) without its dollar limit, and wages already used for another credit in the same subpart, such as the work opportunity credit, are excluded.

The written policy: what makes an employer eligible

Section 45S(c)(1) defines an eligible employer as one with a written policy that provides at least 2 weeks of annual paid family and medical leave to full-time qualifying employees, a proportionate amount to part-time qualifying employees based on the ratio of their expected weekly hours to a full-time employee's, and a rate of payment of at least 50% of the wages normally paid. An employer with qualifying employees who are not covered by title I of the FMLA is an "added employer" and must also include what the IRS calls non-interference language: the policy will not interfere with, restrain or deny the leave rights it creates, and will not discharge or discriminate against anyone for opposing a practice the policy prohibits.

"Family and medical leave" means leave for the FMLA purposes in section 102(a)(1)(A) through (E) or (3) of that Act: the birth or placement of a child, care for a spouse, child or parent with a serious health condition, the employee's own serious health condition, a qualifying military exigency, or care for a covered service member. Section 45S(e)(2) excludes paid vacation, personal leave, and general sick leave unless the leave is specifically designated for those purposes. A general PTO bank earns nothing.

The amended aggregation rule treats all members of a controlled group under section 414(b) and (c) as one employer, so one company in a group cannot adopt a policy and claim the credit while a sister company does not, unless it shows a substantial and legitimate business reason. Section 45S(c)(3)(B)(ii) says that reason cannot be a separate line of business, wage rates or job categories, or state and local leave laws, though it may be the grouping of employees of a common law employer.

State-mandated leave under the amended rule

Before the amendment, leave paid by a state or local government, or required by state or local law, was ignored for every purpose, so an employer in a state with a paid leave program could not count that leave toward its 2-week policy. Section 45S(c)(4) now splits the treatment. State-paid or state-required leave is taken into account in determining the amount of paid family and medical leave the employer provides, so it helps satisfy the policy requirement. It is still not taken into account in determining the amount of the credit. In practice, wages the employer itself pays for qualifying leave, including a top-up above a state benefit, can earn the credit; the state benefit cannot. The Form 8994 instructions (Rev. December 2024) still describe the old rule and predate this change.

Who is a qualifying employee in 2026

Section 45S(d) sets three tests. The employee, as defined in section 3(e) of the Fair Labor Standards Act, must have been employed by the employer for 1 year or more, or, at the employer's election, for not less than 6 months, an option added by P.L. 119-21. For the preceding year, their compensation, determined on an annualized basis and prorated for part-time employees, must not exceed 60% of the highly compensated employee amount under section 414(q)(1)(B)(i). And, also new, the employee must be customarily employed for not less than 20 hours per week.

The Form 8994 instructions give the dollar figure: for the 2026 tax year the prior-year (2025) amount under section 414(q)(1)(B) is $160,000, so the compensation limit is $96,000. Notice 2025-67 keeps the highly compensated threshold at $160,000 for 2026. An employee paid $100,000 in 2025 is not a qualifying employee for 2026 leave, however long they have worked there.

Illustration: 4 weeks of parental leave at three pay rates

The 60% row: 160 hours times $30 times 60% is $2,880 of leave wages; 60% is 10 points above 50%, so the percentage is 12.5% plus 2.5%, or 15%; the credit is $432, and the employer deducts $2,448 of the $2,880. The 4 weeks sit inside the 12-week cap, and the wages sit inside the section 45S(b)(1) ceiling of $4,800 (160 hours at the full $30 rate).

Form 8994, the election, and the wage deduction

Form 8994 figures the credit, and the result joins the general business credit on Form 3800. Partnerships and S corporations must file Form 8994 to pass the credit through; other taxpayers whose only source is a pass-through entity report the amount on Form 3800, Part III, line 4j. The About Form 8994 page lists the January 2021 form and the December 2024 instructions as current; a revision reflecting the 2026 rules had not been posted when this was checked, so watch IRS.gov/Form8994 before filing a 2026 return. Section 45S(h) also lets a taxpayer elect out of the credit for a year, which matters because of section 280C(a): no deduction is allowed for wages equal to the credit figured on wages, or for premiums equal to the credit figured on premiums.

Everything on Form 8994 comes from payroll: each employee's hire date, weekly hours, prior-year compensation, normal hourly rate, and the hours and wages coded to designated family and medical leave rather than PTO. BEG Managed Payroll runs payroll inside the system you already use, from $25 per employee per month, so leave hours and wages are on record when the form is prepared. The credit sits alongside the enlarged employer-provided childcare credit, which P.L. 119-21 changed at the same time, and the rest of the list in the federal tax credits for small businesses guide. Whether a policy adopted mid-year, an election for the 6-month rule, or the premium route produces more credit than it costs in lost deductions is a planning question for the employer's CPA, and the kind of item Forward Tax Planning on the Tax Planning page puts in writing.

Sources: 26 U.S.C. 45S; P.L. 119-21, section 70304; 26 U.S.C. 280C; IRS, Instructions for Form 8994 (Rev. December 2024); IRS, About Form 8994; IRS, Section 45S Employer Credit for Paid Family and Medical Leave FAQs; IRS, Notice 2025-67. Rules and figures checked against these sources on September 26, 2026. This is general information, not tax advice for your situation. Tax services are provided by licensed tax professionals under a separate engagement agreement. BEG does not provide tax advice.