Employer Paid Family Leave Tax Credit: What Changed for 2026
Business owners who provide paid family and medical leave to employees may qualify for a federal tax credit under Internal Revenue Code Section 45S. Changes enacted under the One Big Beautiful Bill Act made the credit permanent and expanded the ways employers can qualify beginning in 2026.
The changes are particularly relevant for small businesses considering employee benefit programs. Employers can now potentially claim the credit on qualifying insurance premiums rather than relying entirely on wages paid when employees actually take family or medical leave.
The revised rules also expand employee eligibility and change how state mandated leave programs interact with the federal credit.
However, the credit is not available simply because a business provides paid time off or maintains a disability insurance policy. Written policy requirements, employee qualifications, the type of leave provided, and the method used to calculate the credit remain important.
These considerations should be evaluated as part of broader proactive business tax planning, particularly when an employer is reviewing compensation and employee benefit arrangements before the beginning of a new tax year.
Key takeaway:
Beginning in 2026, qualifying employers may claim a federal tax credit ranging from 12.5% to 25% of eligible paid family and medical leave wages or qualifying insurance premiums, subject to the applicable rules.
The credit is now permanent. Employers may also elect to include certain employees after six months of employment rather than waiting one year.
Section 45S Is Now a Permanent Federal Tax Credit
Section 45S was originally enacted under the Tax Cuts and Jobs Act of 2017 as a temporary credit.
The provision encouraged employers to voluntarily provide paid family and medical leave by allowing a general business tax credit based on qualifying wages paid during an employee's leave.
Congress subsequently extended the provision several times.
Section 70304 of Public Law 119-21, enacted July 4, 2025, removed the expiration provision and expanded the credit for taxable years beginning after December 31, 2025.
The permanent extension means employers no longer need to evaluate the benefit solely as a temporary federal tax incentive scheduled to expire at the end of a particular year.
However, the credit remains subject to the requirements of Section 45S and the general business credit limitations.
The IRS issued Notice 2026-28 on August 5, 2026, providing initial guidance on the expanded credit, particularly the new insurance premium method.
The Credit Can Be Calculated Using Two Different Methods
Beginning in 2026, an eligible employer may determine the credit using qualifying wages paid during family and medical leave or qualifying insurance premiums paid or incurred for coverage providing those benefits.
The Wage Method
The traditional method calculates the credit using eligible wages paid to qualifying employees while they are taking family or medical leave.
The credit percentage begins at 12.5% when the employer pays 50% of the employee's normal wages during leave.
The credit percentage increases by 0.25 percentage points for each percentage point that the leave pay rate exceeds 50% of normal wages.
The maximum credit percentage is 25% when the employer pays 100% of normal wages.
| Wages paid during leave | Applicable federal credit percentage |
|---|---|
| 50% of normal wages | 12.5% |
| 60% of normal wages | 15% |
| 75% of normal wages | 18.75% |
| 100% of normal wages | 25% |
Under Section 45S(b), the amount of family and medical leave taken into account generally cannot exceed 12 weeks for each qualifying employee during a taxable year.
The credit is also subject to applicable statutory limitations based on the employee's normal wages and the amount of qualifying leave.
The New Insurance Premium Method
The 2026 expansion introduced an additional method for employers maintaining qualifying insurance policies that provide paid family and medical leave benefits.
Under Section 45S(a)(1)(B), an employer may elect to calculate the credit using eligible insurance premiums paid or incurred during the taxable year.
Importantly, the employer may qualify for this method even when no covered employee actually takes family or medical leave during that year.
This is a significant difference from the traditional wage method.
An employer maintaining eligible coverage may incur qualifying premium expenses throughout the year even when employees do not make claims under the policy.
However, not every disability or paid leave insurance premium qualifies.
Notice 2026-28 limits the credit to the portion of premiums attributable to benefits that would qualify under the wage method.
Premiums attributable to nonqualifying employees, nonqualifying leave, or benefits required by state or local law must be excluded from the credit calculation.
Employers Cannot Claim the Same Leave Benefit Twice
Notice 2026-28 clarifies that employers may use both the wage and premium methods when the methods apply to different qualifying benefits.
However, the employer cannot claim a premium based credit and a wage based credit for the same funded benefit.
For example, assume an employer maintains an insurance policy that funds qualifying paid family leave benefits.
If the employer claims a credit for the premiums funding those benefits, it cannot also claim a second credit on the same benefits when the insurer pays or reimburses them.
If a qualifying leave payment is funded partly through an insurance policy and partly through the employer's general assets, the employer may potentially use the premium method for the insured portion and the wage method for the separately funded portion.
The amounts must be separately identified and substantiated.
This distinction is important when evaluating insurance policies that coordinate employer payments, disability benefits, and reimbursements.
Example: Federal Credit for Paid Family Leave Wages
Assume the following:
- A qualifying employee normally earns $2,000 per week.
- The employer maintains a qualifying written family and medical leave policy.
- The employee takes four weeks of eligible family leave.
- The employer pays 100% of the employee's normal wages during the leave.
- The employer satisfies the other Section 45S eligibility requirements.
The employee receives $8,000 of qualifying paid leave wages.
Because the employer pays 100% of normal wages, the applicable credit percentage is 25%.
The potential federal credit is:
$8,000 × 25% = $2,000.
The employer would generally reduce its federal wage deduction by the $2,000 credit under Section 280C(a).
The net federal tax benefit therefore depends on the employer's applicable tax position and the general business credit limitations.
The credit does not represent a reimbursement of the employee's entire leave compensation. It reduces qualifying federal income tax liability, subject to the applicable credit rules.
The Insurance Premium Method Creates a Different Planning Opportunity
Example: Qualifying insurance premiums
Assume a small business maintains an insurance policy covering qualifying paid family and medical leave benefits.
During 2026:
- The business pays $20,000 in premiums attributable entirely to qualifying coverage.
- The policy satisfies the applicable Section 45S requirements.
- The qualifying benefits replace 75% of normal employee wages.
- The covered employees meet the statutory eligibility requirements.
- No employee takes family or medical leave during the year.
The applicable credit percentage is 18.75%.
The potential federal credit is:
$20,000 × 18.75% = $3,750.
The absence of actual leave payments does not automatically disqualify the employer from using the premium method.
However, the calculation assumes that the full $20,000 is attributable to qualifying coverage.
If the policy also covers other benefits or nonqualifying employees, the premium must be allocated appropriately.
This example illustrates the calculation rather than establishing that every employer insurance policy qualifies.
Insurance Policies May Require a Premium Allocation
Notice 2026-28 addresses policies that provide both qualifying and nonqualifying insurance coverage.
For example, an employer may purchase a policy covering family leave, short term disability, and other benefits.
The full insurance premium may not qualify for the federal credit.
The employer must determine which portion of the premium is attributable to coverage that satisfies Section 45S.
The IRS permits a reasonable allocation method when the policy includes both qualifying and nonqualifying coverage.
The allocation must:
- Be consistent with the insurance policy's terms.
- Use objective criteria.
- Be supported by contemporaneous records.
- Be applied consistently throughout the taxable year.
- Be applied consistently among businesses treated as a single employer under the applicable aggregation rules.
Insurance policy schedules, coverage descriptions, employee eligibility information, and insurer premium allocations may be important supporting records.
A business should not assume that an invoice labeled disability insurance automatically establishes the amount eligible for the Section 45S credit.
More Employees Can Qualify Beginning in 2026
The expanded credit also changes the definition of a qualifying employee.
Previously, an employee generally needed at least one year of employment to qualify.
Under amended Section 45S(d), an employer may elect to use a minimum employment period of at least six months.
This can be beneficial for businesses with employees who have not yet completed a full year of service.
The six month alternative is an employer election rather than an automatic replacement of the general one year requirement.
The legislation also expressly requires that qualifying employees customarily work at least 20 hours per week.
Employers should distinguish this employee eligibility requirement from the separate rules for prorating the amount of leave provided to part time employees.
Compensation Limits Still Apply
Section 45S(d) also includes a compensation limitation.
Generally, a qualifying employee cannot have compensation for the preceding year exceeding 60% of the highly compensated employee threshold determined under Section 414(q)(1)(B)(i).
The amended statute includes annualization rules for compensation, including adjustments for qualifying part time employees.
The applicable threshold must be determined for the relevant taxable year rather than assuming that every employee receiving paid leave qualifies.
Employers should retain payroll records establishing employment dates, customary weekly hours, and the compensation used to determine eligibility.
A Written Paid Leave Policy Is Still Required
The expanded credit does not eliminate the written policy requirement under Section 45S(c).
An eligible employer generally must maintain a written policy providing qualifying paid family and medical leave benefits.
The policy must provide at least two weeks of annual paid family and medical leave to qualifying employees who are not classified as part time under the applicable rules.
A proportionate amount of leave must be provided to qualifying part time employees.
The policy generally must also provide compensation during leave of at least 50% of the employee's normal wages.
Employers with qualifying employees who are not protected under the federal Family and Medical Leave Act must also satisfy the applicable noninterference provisions.
These provisions generally prohibit interference with the exercise of rights provided under the employer's policy and retaliation for exercising or asserting those rights.
An employer that provides informal paid leave without an established qualifying written policy should not assume that the payments qualify for the credit.
Not Every Type of Paid Time Off Qualifies
Section 45S generally concerns leave taken for specified family and medical purposes.
Qualifying purposes include:
- The birth of an employee's child and care for the child.
- Placement of a child for adoption or foster care.
- Caring for a spouse, child, or parent with a serious health condition.
- The employee's own serious health condition that prevents performance of the employee's job.
- Certain qualifying circumstances involving military service.
- Caring for a qualifying injured or ill servicemember.
Ordinary vacation, personal leave, and general paid time off are not automatically qualifying family and medical leave.
Likewise, a general sick leave program does not necessarily qualify unless the leave is specifically designated for qualifying purposes and satisfies the applicable statutory requirements.
The substance of the employer's policy matters more than the label assigned to the benefit.
California Paid Family Leave Creates Additional Considerations
California employers must distinguish the federal Section 45S credit from California's existing Paid Family Leave and State Disability Insurance programs.
California provides certain family leave benefits through programs administered by the Employment Development Department.
Those benefits do not automatically create a federal Section 45S credit for the employer.
The 2026 federal amendments allow leave required by state or local law, or paid by state or local government, to be considered when determining whether the employer satisfies the statutory minimum leave requirements.
However, Section 45S(c)(4) continues to exclude state mandated or government funded benefits from the amount used to calculate the federal credit.
This distinction can be important when an employer provides supplemental voluntary benefits above the applicable California requirements.
California employer planning consideration:
An employer may be able to use certain state mandated leave benefits when determining eligibility for the federal credit, while calculating the credit only on qualifying voluntary employer funded wages or insurance premiums.
The employer must still satisfy the applicable written policy requirements and maintain records distinguishing qualifying benefits from state mandated benefits.
An employer paying additional compensation during a California employee's family leave should evaluate whether those payments are voluntary qualifying leave wages or amounts required under applicable law.
Similarly, an insurance policy combining state required and voluntary coverage may require a separate allocation of qualifying premiums.
California Does Not Provide an Equivalent Section 45S Credit
The California Franchise Tax Board confirms that California does not conform to federal Section 45S and has no comparable state income tax credit.
Consequently, a California business may qualify for a federal credit without receiving an equivalent credit on its California income tax return.
The federal deduction reduction under Section 280C also requires attention when reconciling federal and California taxable income.
The appropriate California deduction treatment should be determined under California's separate income tax conformity provisions rather than automatically carrying the federal adjustment into the state calculation.
For additional discussion of differences between federal and California business tax calculations, see California Tax Conformity After SB 711 and SB 1435.
Partnerships and S Corporations Can Also Benefit
The Section 45S credit is a general business credit under Section 38.
Qualifying partnerships and S corporations may calculate the credit at the entity level and report the appropriate credit information to their owners.
The owners generally apply the applicable general business credit limitations when determining how much credit may be used on their individual or other applicable returns.
For a partnership, eligibility depends on the employer's qualifying wage or premium payments, employee classifications, and applicable statutory requirements.
For an S corporation, the business must also consider its payroll structure, employee benefit arrangements, and treatment of shareholder employees.
The credit should not be assumed to apply to every payment made to an owner merely because the owner receives compensation from the business.
Employment status, compensation arrangements, ownership interests, and any applicable related party or other restrictions should be evaluated separately.
The federal credit should also be coordinated with other general business credits and applicable tax limitations.
The Credit Reduces the Related Federal Deduction
Section 280C(a) generally prevents employers from receiving both a full federal deduction for qualifying wages or premiums and a tax credit for the same amount.
When an employer calculates the Section 45S credit using qualifying wages, the federal wage deduction generally must be reduced by the amount of the credit.
The same principle applies to qualifying insurance premiums under the amended Section 280C provisions.
This means that the credit is not an additional benefit that can be evaluated without considering the corresponding deduction adjustment.
For example, a $2,000 credit may require the employer to reduce otherwise deductible federal wage expenses by $2,000.
The total federal tax benefit depends on the employer's tax position and the limitations governing the credit.
The credit is generally reported through Form 8994 and incorporated into the general business credit calculation on Form 3800.
Employers using the new premium method should confirm that they are applying the current 2026 reporting requirements, as earlier Form 8994 instructions predate the statutory changes.
The General Business Credit Limitations Still Apply
Section 45S is included in the general business credit provisions of Section 38.
Consequently, the amount calculated under Section 45S is not necessarily the amount that can be used against the employer's or owner's current year federal income tax.
The general business credit is subject to the limitations of Section 38(c), including calculations involving regular tax liability and tentative minimum tax.
Depending on the facts, unused credits may be subject to the general business credit carryback and carryforward provisions of Section 39.
For businesses with multiple credits, the Section 45S calculation should be incorporated into the complete tax projection.
This is particularly important for pass through business owners whose individual tax liability may determine the amount of credit ultimately usable in a particular year.
Employer Benefit Decisions Should Be Evaluated Before Year End
Employers reviewing compensation and benefit programs for 2027 should consider whether their existing leave arrangements meet the expanded Section 45S requirements.
The review should address:
- Whether the business has an established written paid family and medical leave policy.
- Whether the policy provides the minimum qualifying leave period and compensation replacement rate.
- Whether the employer should elect the six month employment eligibility alternative.
- Whether covered employees meet the required customary weekly hours and compensation limitations.
- Whether the business pays qualifying wages directly or maintains an insurance policy.
- Whether the insurance policy includes benefits that do not qualify for the credit.
- Whether voluntary benefits must be separated from state mandated benefits.
- Whether insurance premium allocations can be substantiated.
- Whether the credit will be usable under the general business credit limitations.
- Whether the business must maintain separate federal and California tax calculations.
A written policy generally should be established before the employer provides the leave for which a credit will be claimed.
Employers should also consider how any new policy affects payroll administration, insurance costs, employee eligibility, and other benefit programs.
The economic cost of the program should be compared with the available federal tax benefit rather than implementing coverage solely because a credit may be available.
Future Treasury Regulations May Clarify Additional Details
Although the expanded Section 45S credit is enacted law, Treasury and the IRS have not completed the regulatory guidance addressing every aspect of the new provisions.
Notice 2026-28 provides guidance that taxpayers may rely upon for taxable years beginning after December 31, 2025, and before publication of the contemplated proposed regulations.
Treasury has requested comments concerning several issues, including:
- Appropriate methods for allocating insurance premiums between qualifying and nonqualifying coverage.
- The treatment of certain voluntary state facilitated insurance arrangements.
- The circumstances under which related employers may qualify for exceptions from the general aggregation rules.
Additional proposed and final regulations may provide further clarification.
The current statutory provisions and published IRS guidance should therefore be distinguished from matters that remain subject to future rulemaking.
Final Takeaway
The permanent expansion of Section 45S creates a meaningful federal tax planning opportunity for employers providing qualifying paid family and medical leave benefits.
Beginning in 2026, eligible employers can potentially calculate the credit using qualifying wages or insurance premiums.
The premium method is particularly significant because it may provide a federal credit even when no employee actually takes qualifying leave during the year.
However, employers must still satisfy the written policy requirements, employee eligibility standards, minimum leave provisions, and substantiation rules.
California employers face additional considerations because California does not provide an equivalent state income tax credit and state mandated benefits cannot automatically be included in the federal credit calculation.
For business owners reviewing employee benefits, the better approach is to evaluate the cost of the proposed benefit program, the eligibility requirements, and the resulting federal and state tax treatment together.
The expanded credit is one of several business tax provisions modified by Public Law 119-21. For additional context, see the effective dates of the OBBBA tax provisions.
