IRS Issues Ruling on Tax Treatment of Contributions and Benefits Under State Paid Family and Medical Leave Programs

The IRS issued Rev. Rul. 2025-4 on January 15, 2025, regarding the federal income and employment tax treatment and related reporting requirements of contributions to, and benefits paid under, a mandatory state paid family and medical leave (PFML) program. The ruling includes various tax treatment scenarios containing the IRS' guidance with respect to contributions and benefits under a state PFML program. Notably, the IRS informs that employer contributions made to a state-mandated PFML program generally may be deducted by the employer as an excise tax and that benefits paid by state PFML programs do not constitute wages paid to employees.

State Paid Family and Medical Leave Programs

While there is no federal law providing or guaranteeing access to paid family and medical leave for workers in the private sector, some states have implemented state level paid leave programs and requirements. These mandated programs provide wage replacement to workers for periods in which they must take time off from work to care for themself or a family member. To fund these programs, in-state employers and employees are required to make contributions with respect to the employee to the state's PFML program fund, which is operated and administered by the state. The employer and employee contributions must generally be equal to a specified percentage of the employee's average weekly wages. The ruling does not address the tax treatment of an alternative arrangement allowed under the state law under which an employer may establish and maintain a private plan for the payment of family and medical leave benefits to eligible employees in lieu of making contributions to the state fund.

Tax Treatment of Employer and Employee Contributions

Employer Contributions. Employers may deduct employer contributions under a PFML program as an excise tax, and the employer contributions are not required to be included in the employees' federal gross income.

Employee Contributions. In contrast, contributions required to be deducted from an employee's pay under a PFML program must be deducted on an after-tax basis. Accordingly, employers must include an employee's contributions under a PFML program as wages for purposes of federal income tax and FICA taxes, as well as reporting on the employee's Form W-2. Employees may deduct the contribution as state income tax, provided that the employee itemizes deductions and subject to the $10,000 limit on state and local tax deductions under current law.

Employer Pick-up Contributions. Under some state PFML programs, employers may voluntarily pay all or a portion of an employee's otherwise mandatory contributions, rather than withholding such amounts from the employee's wages (an "employer pick-up"). In this scenario, employers may deduct the employer pick-up contribution amount as a business expense. Employers must include the voluntary contribution as wages on the employee's Form W-2, and the pick-up contribution is additional compensation to the employee and is included in their federal gross income as wages. Consequently, the employer must either withhold income taxes and FICA taxes (as applicable) from the employee's other wages on the amount of the pick-up contribution or gross-up the contribution. Employees may deduct pick-up contributions as state income tax, provided that the employee itemizes deductions and subject to the $10,000 limit on state and local tax deductions under current law.

Taxability of Benefits Paid and Received

Family Leave Benefits. Employees must include the amounts attributable to employer contributions in their federal gross income, however such contribution amounts will not constitute wages. Employees must include the amounts attributable to their own employee contributions and/or any employer pick-up of such employee contribution in their federal gross income, however these amounts do not constitute wages. As a result, the benefits will generally not be subject to federal withholding unless the employee is subject to backup withholding.

Medical Leave Benefits. Employees must include the amounts attributable to employer contributions in their federal gross income, however such contribution amounts will not constitute wages. Employees may exclude the amounts attributable to their employee contributions and/or any employer pick-up of such employee contribution from their federal gross income. In states where the benefit is funded entirely by employee contributions, such as New York, these benefits will be entirely tax-free. Because the benefits are not wages, the benefits will generally not be subject to federal withholding unless a portion of the benefit is taxable and the employee is subject to backup withholding.

Transition Period for Enforcement and Administration

The IRS indicted that 2025 will be regarded as a transition period for purposes of enforcement and administration of the reporting requirements and other rules described in Rev. Rul. 2025-4. The transition period is intended to provide the District of Columbia, states, and employers adequate time to adjust their reporting structures and to facilitate an orderly transition to compliance.