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New IRS Revenue Ruling Provides Tax Guidance for Paid Family and Medical Leave Laws
New IRS Revenue Ruling Provides Tax Guidance for Paid Family and Medical Leave Laws
The IRS has published Revenue Rule 2025-4, which provides much-needed guidance on federal tax treatment of state paid leave laws.
Over the last several years, many states have passed mandatory paid leave laws allowing employees to continue to receive at least partial wages when they cannot work due to injury, illness, or disability to themselves or covered family members. While these state laws provided clear guidance on when and how much leave could be taken, little guidance was given on whether the payments received were taxable.
Thankfully, IRS Revenue Rule 2025-4 addresses the tax treatment of both contributions and benefits:
Taxation of Contributions
- Employer Contributions: Employers may consider mandatory contributions to a state’s paid family and medical leave fund to be excise taxes and therefore not subject to FICA, FUTA, or federal income tax
- Employee Contributions: Employees may treat their contributions as after-tax contributions and, if an employee itemizes deductions on their personal income tax filing, deduct the amount the contribute. However, the employee deduction cannot exceed the state income tax deduction limitation.
- Employer Pick-Up: Some employers have chosen to cover both the required employee and employer contribution. The revenue ruling makes clear that employers must include employer pick-up contributions as additional compensation subject to normal employment taxes. The employee can deduct these contributions as state income tax to the extent permitted.
See Table 1 for more information.
In terms of the enforcement and administration of this new rule, calendar year 2025 is being treated as a transition period.
Taxation of Leave Benefits
- Family Leave Benefits: Wage replacement benefits during leave to care for a family member with a serious health condition are income but are not reportable as wages subject to FITW, FICA, and FUTA. The IRS compared these benefits to Social Security payments that are not treated as remuneration from employment. However, the state must report the payments to the employee on Form 1099 as income subject to FIT.
- Medical Leave Benefits: Payments paid by the state are excluded from income to the extent that the coverage was paid by the employee and not the employer. The portion of the benefit that is attributable to employer contributions funded by the employer is included in the employee’s gross income, treated as wages and considered third-party sick pay in income and wages.
- The guidance includes additional examples of taxation of benefits where employee contributions have been paid by the employer for both medical and family leave benefits.
See Table 2 for more information.
As expected, the burden of correct reporting falls on the employer. Calendar year 2025 is being treated as a transition period for purposes of enforcement and administration. However, employers should review current processes as soon as possible with their tax professional, payroll, and human resource teams to make sure contributions and benefits are appropriately taxed and reported on employee W-2s.
Lastly, it should be noted that page 3 of the IRS document indicates “This revenue ruling does not address the Federal tax treatment of employers’ or employees’ contributions to private or self-insurance family or medical leave plans or the amounts received by the employees as benefits under these plans.”
For more information on legal changes impacting employers this year, check out this on-demand webinar event: New Year, New Laws: What Federal HR Regulations are Changing in 2025?