Guidance has been issued by the IRS for employers looking to claim a credit under IRC §45S for paid family and medical leave in Notice 2018-71.  This provision was added to the law for two years as part of the Tax Cuts and Jobs Act (TCJA) enacted in late 2017.

Under the Family and Medical Leave Act of 1993 (FMLA) an employee is required to grant covered employees up to 12 weeks of leave for certain medical issues arises related to their health or that of certain related persons.  However, an employer is not required to pay employees while on such leave.  Rather, FMLA was meant to assure the employee had a job to return after coming back from such leave.

As an incentive to employers to pay employees at least a portion of their salaries during the leave period, TCJA added a credit available for 2018 and 2019 for employers that adopt qualified programs.  The amount of the credit is described in the Notice as follows:

Section 45S(a)(1) provides that, in the case of an eligible employer, the credit is an amount equal to the applicable percentage of the amount of wages paid to qualifying employees during any period in which the employees are on family and medical leave. Under section 45S(a)(2), the term “applicable percentage” means 12.5 percent increased (but not above 25 percent) by 0.25 percentage points for each percentage point by which the rate of payment exceeds 50 percent.

Under section 45S(b)(3), the amount of family and medical leave that may be taken into account with respect to any qualifying employee for any taxable year may not exceed 12 weeks. Section 45S(b)(1) provides that the credit with respect to any qualifying employee for any taxable year cannot exceed an amount equal to the product of the employee's normal hourly wage rate for each hour (or fraction thereof) of actual services performed for the employer and the number of hours (or fraction thereof) for which family and medical leave is taken.[1]

The notice begins by roughly describing the requirements for such programs.

To be eligible to claim the credit, an employer must have a written policy that satisfies certain requirements. First, the policy must cover all qualifying employees; that is, all employees who have been employed for a year or more and were paid not more than a specified amount during the preceding year. In general, in determining whether an employee is a qualifying employee in 2018, the employee must not have had compensation from the employer of more than $72,000 in 2017. Second, the policy must provide at least two weeks of annual paid family and medical leave for each full-time qualifying employee and at least a proportionate amount of leave for each part-time qualifying employee. Third, the policy must provide for payment of at least 50 percent of the qualifying employee’s wages while the employee is on leave. Fourth, if an employer employs qualifying employees who are not covered by title I of the FMLA, the employer’s written policy must include language providing “non-interference” protections, as described in Section A of this notice. Thus, the written policy must incorporate the substantive rules that must be met in order for an employer to be eligible for the credit.

Any leave paid by a State or local government or required by State or local law is not taken into account for any purpose in determining the amount of paid family and medical leave provided by the employer. Thus, any such leave is not taken into account in determining the amount of paid family and medical leave provided by the employer, the rate of payment under the employer’s written policy, or the determination of the credit.

The Notice indicates that it provides guidance on the following topics:

This notice includes sections on the following topics:

A. Eligible Employer

B. Family and Medical Leave

C. Minimum Paid Leave Requirements

D. Calculating and Claiming the Credit

E. Effective Date

The Notice consists of a series of questions and answers on those topics.

An employer does not have to be subject to Title I of FMLA in order to qualify for the credit.  Rather, an employer is eligible if it has a qualified written policy in place to provide paid family and medical leave, satisfies the minimum paid leave requirements and, if applicable, contains non-interference language.[2]

The Notice describes requirements for the written program as follows:

An eligible employer's written policy must provide paid family and medical leave, as described in Section B of this notice (Q&A-8 through Q&A-11) and must satisfy the minimum paid leave requirements set forth in Section C of this notice (Q&A-12 through Q&A-21). In summary, an eligible employer's written policy must provide all qualifying employees with at least two weeks of paid family and medical leave (prorated for part-time employees), at a rate of at least 50 percent of the employee's normal wages, as these terms are defined and described in more detail in Sections B and C of this notice. In addition, if the employer employs any qualifying employees, as defined in Q&A-12, who are not covered by title I of the FMLA, the employer's written policy must include “non-interference” language, as set forth in Q&A-3.[3]

If the employer has employees not required to be covered by the FMLA leave rules, the following special rules apply to the program if that employer wishes to be eligible for the credit.  The Notice provides:

If an employer employs at least one qualifying employee who is not covered by title I of the FMLA (including any employee who is not covered by title I of the FMLA because he or she works less than 1,250 hours per year), in accordance with section 45S(c)(2), the employer must include “non-interference” language in its written policy and comply with this language to be an eligible employer. This requirement applies to: (a) an employer subject to title I of the FMLA that has at least one qualifying employee who is not covered by title I of the FMLA, and (b) an employer not subject to title I of the FMLA (that, thus, has no employees covered by title I of the FMLA). The  “non-interference” language must ensure that the employer will not interfere with, restrain, or deny the exercise of, or the attempt to exercise, any right provided under the policy, and will not discharge, or in any other manner discriminate against, any individual for opposing any practice prohibited by the policy. The following “non-interference” language is an example of a written provision that would satisfy section 45S:

[Employer] will not interfere with, restrain, or deny the exercise of, or the attempt to exercise, any right provided under this policy. [Employer] will not discharge, or in any other manner discriminate against, any individual for opposing any practice prohibited by this policy.[4]

In order to be eligible to claim the credit for payments made related to a particular employee’s leave, the plan generally must be in place prior to the beginning of that leave.[5]  However, a special rule applies to determine the effective date of the plan in 2018, since the IRS is only providing guidance in late September of 2018.  The Notice provides:

For an employer's first taxable year beginning after December 31, 2017, a written leave policy or an amendment to a policy (whether it is a new policy for the taxable year or an existing policy) will be considered to be in place as of the effective date of the policy (or amendment), rather than a later adoption date, if (a) the policy (or amendment) is adopted on or before December 31, 2018, and (b) the employer brings its leave practices into compliance with the terms of the retroactive policy (or retroactive amendment) for the entire period covered by the policy (or amendment), including making any retroactive leave payments no later than the last day of the taxable year.[6]

The paid leave provided for in the plan must meet certain requirements listed in the Notice:

For an employer to be eligible to claim the credit, an employer's written policy must meet certain minimum requirements with respect to paid family and medical leave, as described in section 45S(c)(1) and (c)(2). These requirements are:

(1) the policy must provide at least two weeks of annual paid family and medical leave to all qualifying employees who are not part-time employees, and at least a proportionate amount of paid family and medical leave to qualifying employees who are part-time employees,

(2) the policy must require a rate of payment that is not less than 50 percent of the wages normally paid to the qualifying employee for services performed for the employer, and

(3) if the employer employs one or more qualifying employees who are not covered by title I of the FMLA, the employer's written policy also must include the “non-interference” language described in Q&A-3.

Under section 45S(c)(4), any leave that is paid by a State or local government or required by State or local law is not taken into account for any purpose in determining the amount of paid family and medical leave provided by the employer.[7]

The Notice provides that the law does not require that employees be given specific notice of the employer’s policy in this area, but if the employer does make any communication to employees the policy is only going to qualify if the communication is designed to reach all eligible employees.[8]

To qualify for the credit, the plan must limit its use to FMLA purposes. If the plan allows other sorts of paid leave, the plan will not qualify for the credit even if the leave is actually used for an FMLA approved purpose.[9]

The Notice provides two examples of acceptable plans and one not acceptable arrangement:

Example 1. Facts: Employer's written policy provides six weeks of annual paid leave for the birth of an employee's child, and to care for that child (an FMLA purpose). The leave may not be used for any other reason. No paid leave is provided by a State or local government or required by State or local law.

Conclusion: Employer's policy provides six weeks of family and medical leave under section 45S.

Example 2. Facts: Employer's written policy provides three weeks of annual paid leave that is specifically designated for any FMLA purpose and may not be used for any other reason. No paid leave is provided by a State or local government or required by State or local law.

Conclusion: Employer's policy provides three weeks of family and medical leave under section 45S.

Example 3. Facts: Employer's written policy provides three weeks of annual paid leave for any of the following reasons: FMLA purposes, minor illness, vacation, or specified personal reasons. No paid leave is provided by a State or local government or required by State or local law.

Conclusion: Employer's policy does not provide family and medical leave under section 45S because the leave is not specifically designated for one or more FMLA purposes and can be used for reasons other than FMLA purposes. This is true even if an employee uses the leave for an FMLA purpose.

However, there is a limited exception provided for a plan that provides for leave to care for a class of individuals beyond those for which FMLA leave is required.  For instance, a plan that grants leave to care for a grandchild or grandparent, in addition to relatives covered by the FMLA rule, would still be an eligible plan.[10]

The Notice provides the following example of such a plan:

Example. Facts: Employer's written policy provides four weeks of annual paid leave to care for family members with a serious health condition. The policy's definition of “family members” includes the individuals specified in the FMLA (spouse, children, and parents), and also includes grandparents, grandchildren, and domestic partners. Employee uses one week of annual paid leave to care for her grandmother, and at a later time, uses one week of annual paid leave to care for her son.

Conclusion: Employer's policy provides paid leave specifically designated for an FMLA purpose. Although the paid leave taken by Employee to care for her grandmother is not family and medical leave under section 45S, and Employer may not claim the credit for this leave, the paid leave taken by Employee to care for her son is family and medical leave under section 45S for which Employer may claim the credit, assuming all other requirements for the credit are met.

The plan cannot exclude any class of otherwise eligible employees.  As the examples note, this means that if an employer has an insured short-term disability program that does not apply to any pre-existing conditions an employee might have had before entering the program, it will not qualify for the credit:

Example 1. Facts: Employer has an insured short-term disability plan that provides disability benefits to any employee who becomes disabled after having completed six months of continuous service. Under the plan, a disability caused by, or resulting from, a pre-existing condition is not covered if the disability begins in the first 12 months after the effective date of coverage. For purposes of the plan, a pre-existing condition is one for which an employee consulted a physician, received medical treatment, or took prescribed drugs in the three months immediately prior to the effective date of coverage. The exclusion from coverage for pre-existing conditions applies to all employees of the employer during the applicable 12-month period.

Conclusion: Employees subject to the pre-existing condition exclusion are effectively not covered under the plan when they first become qualifying employees. In addition, in some cases, the requirement that an employee complete six months of continuous service might exclude some qualifying employees. Therefore, the plan will not in all cases cover all qualifying employees, and Employer may not claim the credit under section 45S for paid family and medical leave provided under the written policy with respect to any employees.

Example 2. Facts: Same facts as in Example 1, except that Employer adopts a written policy that provides for paid leave to any qualifying employee who is not covered under the short-term disability plan as a result of the six months of service requirement or the pre-existing condition exclusion. This leave is paid from Employer's general assets and the length of the paid leave is the same as the leave that would have been available under the short-term disability plan if neither the six months of service requirement nor the pre-existing condition exclusion applied to a qualifying employee.

Conclusion: Taking into account the leave available under Employer's insured short-term disability plan and Employer's supplemental self-insured paid leave arrangement as permitted under Q&A-4, Employer's written policy does not exclude any classification of qualifying employees and, assuming all other requirements for the credit are met, Employer may claim the credit under section 45S for paid family and medical leave provided under the written policy.[11]

The Notice provides the following examples for calculating the “applicable percentage”:

Example 1. Facts: Employer's written policy provides each qualifying employee with four weeks of annual paid family and medical leave at a rate of payment of 75 percent of the wages normally paid to the employee.

Conclusion: Because the rate of payment under the policy exceeds 50 percent by 25 percentage points, the base applicable percentage of 12.5 percent is increased by 6.25 percent (.25 percent multiplied by 25), for an applicable percentage of 18.75 percent.

Applicable Percentage = 12.5 percent + (0.25 percent x 25) = 
12.5 percent + 6.25 percent = 18.75 percent

Example 2. Facts: Same facts as Example 1, except that Employer's written policy provides each qualifying employee who has at least 10 years of service a rate of payment of 100 percent of the wages normally paid to the employee for services performed by the employer, rather than 75 percent.

Conclusion: Because the rate of payment for a qualifying employee who has at least 10 years of service is 100 percent (which is 50 percentage points greater than 50) the base applicable percentage for these employees is increased by 12.5 percent (0.25 percent multiplied by the 50). The applicable percentage with respect to such an employee is therefore 25 percent (the base percentage of 12.5 percent, plus 12.5 percent). For a qualifying employee who has less than 10 years of service, the applicable percentage is the same as determined in Example 1.

Calculation for employee who has at least 10 years of service:

Applicable Percentage=12.5 percent + (0.25 percent x 50) =
12.5 percent + 12.5 percent = 25 percent[12]

The Notice goes on to provide the following examples for calculating the credit:

Example 1. Facts: Employer pays wages to Employee that qualify as a research expense for purposes of determining the amount of Employer's research credit under section 41(a). The research credit under section 41(a) is a general business credit allowed under section 38. Some of the wages paid to Employee for the performance of qualified services under section 41(b) were paid while Employee was on family and medical leave.

Conclusion: For purposes of determining the amount of Employer's credit under section 45S, Employer must exclude from the wages paid while Employee was on family and medical leave any wages treated as a qualified research expense for purposes of determining the amount of Employer's research credit under section 41(a).

Example 2. Facts: Employer is tax-exempt under section 501(a) as an educational organization described in section 501(c)(3). Employment with Employer is not employment for purposes of FUTA tax pursuant to section 3306(c)(8); thus, compensation paid by Employer is not FUTA wages within the meaning of section 3306(b). Although Employer is exempt from federal income tax under section 501(a), it earns unrelated business taxable income from a trade or business that is not substantially related to the performance of Employer's exempt purpose. Employer maintains a written paid leave policy that provides at least two weeks of paid family and medical leave to all qualifying employees, including those performing services for the unrelated trade or business. Employer would like to claim the credit against its unrelated business income tax liability.

Conclusion: Because Employer does not pay FUTA wages within the meaning of section 3306(b), compensation paid by Employer does not constitute wages for purposes of section 45S(g). Consequently, amounts paid by Employer to its employees while on paid family and medical leave are not eligible for the credit.[13]

Employers who claim the credit must reduce the deduction for wages by the amount of credit claimed.[14]

The credit will be claimed by the employer on Form 8994, Employer Credit for Paid Family and Medical Leave, and Form 3800, General Business Credit.[15]

[1] Notice 2018-17, Section D

[2] Notice 2018-71, Q&A 1

[3] Notice 2018-71, Q&A 2

[4] Notice 2018-71, Q&A 3

[5] Notice 2018-71, Q&A 5

[6] Notice 2018-71, Q&A 6

[7] Notice 2018-71, Section C

[8] Notice 2018-71, Q&A 7

[9] Notice 2018-71, Q&A 9

[10] Notice 2018-71, Q&A 10

[11] Notice 2018-71, Q&A 15

[12] Notice 2018-71, Q&A 22

[13] Notice 2018-71, Q&A 23

[14] Notice 2018-71, Q&A 30, IRC §280C

[15] Notice 2018-71, Q&A 31