IRS employer paid leave credit guidance and rules

The Internal Revenue Service (IRS) recently updated its frequently asked questions on §45S, the employer credit for paid family and medical leave, providing additional clarity on eligibility, calculation and documentation for a credit that has been available since 2018. Tax professionals should review these FAQs and ensure their clients understand the credit’s requirements, which have significant implications for planning and compliance.

What is the §45S paid leave credit?

Section 45S allows eligible employers to claim a federal general business tax credit traditionally based on wages paid to qualifying employees while they are on paid family and medical leave. The credit is intended to help offset the costs employers incur when providing paid leave for events such as the birth or adoption of a child, caring for a family member with a serious health condition, or handling certain military-related exigencies.

The credit applies to wages paid during family and medical leave for up to 12 weeks per employee per taxable year. The base credit rate is 12.5% of qualified wages when the employer pays 50% of the employee’s normal wages during leave. This rate increases incrementally, up to a maximum of 25% if the employer pays the employee’s full wages during the leave period.

Beginning with tax years starting after Dec. 31, 2025, the One Big Beautiful Bill Act (OBBBA) permanently extends the §45S credit and expands it to allow certain employers to calculate the credit based on qualifying paid family and medical leave insurance premiums, even if no leave is taken. IRS guidance has not yet been updated to reflect these enhancements.

Who can claim the credit?

To be eligible for the credit, an employer must have a written paid family and medical leave policy that meets specific requirements:

• The policy must provide all qualifying full-time employees at least two weeks of paid family and medical leave annually, with a prorated amount for part-time employees.
• The leave must pay at least 50% of the employee’s normal wages.
• The policy must include non-interference and anti-discrimination provisions, ensuring that employees are not discouraged or penalized for taking leave.

A qualifying employee is one who has worked for the employer for at least one year and whose prior-year compensation does not exceed 60% of the highly compensated employee threshold under §414(q)(1)(B) for that tax year. The IRS updates this compensation limit annually for inflation (for example, $96,000 for 2026).   

What types of leave qualify?

§45S requires that paid family and medical leave be specifically designated for reasons recognized under the federal Family and Medical Leave Act (FMLA), including:

• Caring for a new child (birth, adoption or foster placement)
• Caring for a spouse, parent or child with a serious health condition
• The employee’s own serious health condition that prevents them from working
• Certain military-related exigencies or care for a covered service member who is a spouse, child, parent or next of kin

Paid vacation, personal leave or short-term disability that is not explicitly designated for an FMLA purpose generally does not qualify for the credit even if used for an FMLA-qualifying reason, unless it is structured to meet the family and medical leave requirements.

Tax impact and interaction with deductions 

Employers who claim the §45S credit must reduce their deduction for wages paid by the amount of the credit claimed. Additionally, wages used to calculate this credit cannot be used to claim other general business credits. Accurate leave and payroll records are essential to support credit claims and withstand IRS scrutiny.

Practical advice for tax professionals

To help clients maximize the benefits of §45S and remain compliant, tax professionals should:

• Review leave policies: Ensure clients’ written paid leave policies meet §45S requirements, including minimum paid leave and non-interference language.
• Document leave and wages: Confirm that payroll systems accurately track leave taken, wages paid during leave and employee eligibility to support credit claims.
• Coordinate with benefits advisors: Work with HR or benefits consultants to design leave policies or insurance-based PFML arrangements that optimize tax credits while complying with labor laws.

Section 45S remains underutilized despite its potential value. By understanding the OBBBA enhancements and proactively advising clients, tax professionals can help employers maximize available tax relief and stay compliant with evolving rules.