The IRS recently issued its first-ever guidance on the federal income and employment tax treatment of contributions made to, and benefits paid from, a state-run paid family and medical leave (PFML) program, as well as the related reporting requirements. This has become an area of concern for many employers since more than a dozen states1 have enacted PFML laws without any federal guidance on how to tax the premiums paid to and benefits paid from such programs.
In 2024, the governors of nine states asked the IRS to issue rules on PFML programs, to ensure that there would not be double taxation on both the premiums paid and benefits received. Generally, state-mandated PFML programs provide income replacement for a certain number of weeks for employees who cannot work due to family reasons (such as the birth or adoption of their child) or for medical reasons (such as the employee’s own serious health condition).
Rev. Rul. 2025-4 provides rules for employers operating in the states (and the District of Columbia) that have mandatory PFML programs and for employees working in those states. These state programs pay employees who can’t work because of non-occupational injuries to themselves or family members, as well as sickness and disabilities. While the details of the programs vary substantially from state to state, PFML programs generally operate as social insurance programs, with premium contributions from both employers and employees and benefits paid at a fixed rate, based on the employee’s wages.
The ruling does not address privately insured or self-insured PFML arrangements, even when a state permits employers to use a private plan instead of participating in the state-run PFML program.
The IRS provided two helpful charts summarizing the federal tax rules for contributions to and benefits paid from such PFML programs (see below).
2025 Transitional Relief
The ruling is effective for PFML benefits paid by a state on or after January 1, 2025. However, it provides transition relief for states and employers for calendar year 2025 from withholding, payment, and information reporting requirements for state PFML benefits. For 2025 only, employers who voluntarily “pick up” the required employee contribution into a state PFML fund are not required to treat those amounts as wages for federal employment tax purposes.
BDO Insight
- It is unusual for IRS revenue rulings to be effective prospectively and to request comments (which are due by April 15, 2025), which indicates that further changes may be forthcoming. Nevertheless, employers should begin to update their payroll systems to come into compliance with the new rules starting with the 2026 calendar year. Such changes often take significant time to implement.
- Failure to accurately reflect amounts on an employee’s Form W-2 can subject the employer to IRS penalties. The guidance places new administrative burdens on employers (and their payroll systems) to understand the income and employment tax consequences of such state PFML programs, and to coordinate with the states to obtain information that may be required to correctly report taxable benefits (in a manner similar to that which exists for employers that utilize a third-party insurer to administer short-term or long-term disability). Thus, employers will be expected to correctly determine the taxable and nontaxable contributions and benefits for payroll processing and W-2 reporting purposes. Employers should proactively review their payroll practices to ensure compliance. BDO’s Global Employer Services (GES) Employment Tax Services team can help.
Key Points
The guidance draws important distinctions on how contributions and benefits are treated for federal income and employment tax purposes. Employers will need to pay careful attention to these new rules. The guidance clarifies the following key points:
- Employers can deduct their contributions to state mandatory PFML programs as a payment of an excise tax.
- Employees can deduct their contributions to such programs as a payment of state income tax, if the employee itemizes deductions, to the extent the employee’s deduction for state income taxes does not exceed the state income tax deduction limit. However, required employee contributions to the state PFML program are not excludible from income under IRC Section 106 (i.e., the contributions are after-tax, not pre-tax).
- Employees who receive state-paid family leave payments must include those amounts in the employee’s gross income. Generally, the IRS considers benefits that replace wages during an employee’s leave as wages for income and employment tax purposes, unless the benefits qualify for an exclusion. Paid family leave is generally not eligible for any exclusion. Employees also do not have a “tax basis” in employee or employer pick-up contributions previously treated as taxable wages.
- Employees who receive state paid medical leave payments must include the amount attributable to the employer’s portion of the contributions in the employee’s gross income and such amount is subject to both the employer and employee share of Social Security and Medicare taxes. The amount attributable to the employee’s portion of the contributions is excluded from the employee’s gross income and is not subject to Social Security or Medicare taxes.
Thus, except for leave for the employee’s own injury or illness, PFML is not accident or health insurance, so most PFML benefits will be taxable to the employee.
Tax Treatment of Contributions to State Paid Family and Medical Leave Programs
| Type of Contributions | Consequence to Employer | Consequence to Employee |
| Employer Contribution | Employer may deduct the employer contribution as an excise tax under IRC Section 164. | Employee does not include the employer contribution in the employee’s federal gross income. |
| Employee Contribution | Employer must include the employee contribution as wages on employee’s Form W-2. | The employee contribution is included in the employee’s federal gross income as wages. Employee may deduct the employee contribution as state income tax under IRC Section 164, if the employee itemizes deductions on the employee’s federal income tax return, but only to the extent the deduction for state tax paid does not exceed the SALT deduction limitation provided under IRC Section 164(b)(6). |
| Employer Pick-up of Employee Contributions | Employer may deduct the employer pick-up payment that the employer pays from an employer’s funds as an ordinary and necessary business expense under IRC Section 162. Employer must include the employer voluntary payment as wages on the employee’s Form W-2. | The employer pick-up is additional compensation to the employee and is included in the employee’s federal gross income as wages. Employee may deduct the employer pick-up of the employee contribution as state income tax under IRC Section 164, if the employee itemizes deductions on the employee’s federal income tax return, but only to the extent the deduction for state tax paid does not exceed the SALT deduction limitation provided under IRC Section 164(b)(6). |
Tax Treatment of Benefits Paid from State Paid Family and Medical Leave Programs
| Type of Benefits | Amount Attributable to Employer Contribution | Amount Attributable to Employee Contribution |
| Family Leave Benefits | Employee must include the amount attributable to the employer contribution in the employee’s federal gross income (employer contribution not previously included in the employee’s federal gross income). This amount is not wages. State must file with the IRS and furnish to the employee a Form 1099 to report these payments. | Employee must include the amount attributable to the employee contribution, as well as to any employer pick-up of the employee contribution, in the employee’s federal gross income. This amount is not wages. State must file with the IRS and furnish to the employee a Form 1099 to report these payments. |
| Medical Leave Benefits | Employee must include the amount attributable to the employer contribution in an employee’s federal gross income (employer contribution not previously included in employee’s federal gross income) except as otherwise provided in IRC Section 105. This amount is wages. The sick pay reporting rules apply to the medical leave benefits attributable to employer contributions. These payments are third-party payments (by a party that is not an agent of the employer) of sick pay. | The amount attributable to the employee contribution, as well as to any employer pick-up of the employee contribution, are excluded from the employee’s federal gross income. |
Please visit BDO’s Global Employer Services page for more information on how BDO can help.
Resources
1 As of January 30, 2025, California, Colorado, Connecticut, Delaware, Hawaii, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Puerto Rico, Rhode Island, Washington, and Washington, DC mandate paid leave for an employee’s own serious health condition or disability. Except for Hawaii and Puerto Rico, these states also require paid family leave for the birth or adoption of a child, to care for a seriously ill or injured family member, and for certain other matters. New Hampshire and Vermont have voluntary PFML programs. Alabama, Arkansas, Florida, Kentucky, South Carolina, Tennessee, Texas, and Virginia permit private insurers to provide group family leave insurance policies for employers.