The IRS recently issued Revenue Ruling 2025-4 to clarify the federal income and employment tax treatment of contributions and benefits paid under state-mandated Paid Family and Medical Leave (PFML) programs. This ruling addresses the tax implications for both employers and employees, especially in states like State X which is used as a model throughout the ruling. Let’s break down each aspect of this ruling in detail.

Understanding the Context: State PFML Programs

State PFML programs are designed to provide wage replacement to workers who need to take time off work due to various reasons. These reasons include:

• Personal Medical Needs: An employee’s own non-occupational injuries, illnesses, or medical conditions.
• Family Caregiving: Caring for a family member (child, spouse, parent, etc.) with a serious health condition.
• Family Bonding: Bonding with a new child (birth, foster care, or adoption).
• Military Exigencies: Addressing certain qualifying exigencies related to a family member’s active duty.
• Domestic Violence: Addressing certain medical or non-medical needs arising from domestic violence.

These programs are funded through mandatory contributions from both employers and employees. The goal is to provide a safety net for workers during times when they cannot work.

The State X Model: Contributions

In the scenarios presented in Rev. Rul. 2025-4, State X’s program requires employers and employees to make contributions to a State-administered PFML Fund. For 2025, the standard contribution rate is 1% of each employee’s weekly wages. Here’s how the contributions work:

• Employer’s Share: The employer is required to contribute 40% of the standard contribution rate (1%) multiplied by each employee’s weekly wages.
• Employee’s Share: The employer is required to withhold up to 60% of the standard contribution rate (1%) from each employee’s wages.
• Employer Pick-Up Option: Employers may choose to voluntarily pay all or a portion of the employee’s required contribution instead of withholding it from the employee’s wages. This “employer pick-up” is not included in the employee’s wages for calculating the employee’s weekly wages under State X law.

Detailed Tax Treatment of Contributions

Rev. Rul. 2025-4 specifies the following tax treatments:

• Employer Contributions as Excise Tax:
  • Nature: The 40% contribution that the employer is required to make is considered a mandatory, compulsory exaction by the state for the purpose of raising revenue for public purposes.
  • Federal Law: Under Federal tax law, a tax is a mandatory exaction imposed by a legislative body for the purpose of generating government revenue. This includes taxes paid into a separate fund if the fund is established for public purposes and used to discharge a government function.
  • Deduction: This employer contribution is treated as a state excise tax. Under Section 164(a) of the Internal Revenue Code, employers can deduct these contributions as a business expense paid or accrued in carrying on their trade or business.
  • Employee Impact: These employer-paid amounts are not included in the employee’s gross income. The employee does not receive an accession to wealth from this payment and is not taxed on this amount.
  • Relevant Authority: Flint v. Stone Tracy Co., 220 U.S. 107, 158 (1911); Rev. Rul. 81-194, 1981-2 C.B. 54; and the flush language of § 164(a).
• Employee Contributions as State Income Tax:
  • Nature: The portion of the standard contribution rate (up to 60%) that is withheld from an employee’s wages is considered a mandatory payment by the employee for the purpose of raising state revenues.
  • Federal Law: The ruling explains that when a tax is tied to the occasion of a taxpayer’s income, and the amount of that tax is determined as a factor of the taxpayer’s income, such a tax is considered to be an “income” tax within the meaning of § 164(a)(3).
  • Deduction: Employee contributions are treated as state income taxes and are deductible under Section 164(a)(3) of the IRC. However, this deduction is only available if the employee itemizes deductions and is subject to the limitations of the State and Local Tax (SALT) deduction cap of $10,000 per year. The SALT deduction limitation was added by the Tax Cuts and Jobs Act and is effective for tax years beginning after December 31, 2017, and before January 1, 2026.
  • Gross Income: The amount withheld is included in the employee’s gross income under Section 61. This is because the amounts withheld are used to satisfy the employee’s own tax liability, even though the employer remits the amount to the state. The amounts are also considered “wages” for Federal employment tax purposes under §§ 3121(a), 3306(b), and 3401(a).
  • Relevant Authority: McGowan v. Commissioner, 67 T.C. 599, 608-11 (1976); Rev. Rul. 89-16, 1989-1 C.B. 76; Cohen v. Commissioner, 63 T.C. 267, 278-79 (1974), aff’d, 543 F.2d 725 (9th Cir. 1976); Trujillo v. Commissioner, 68 T.C. 670, 673-75 (1977)
• Employer Pick-Up of Employee Contributions:
  • Nature: When an employer voluntarily pays all or part of an employee’s otherwise mandatory contribution to the PFML fund, that payment represents a discharge of the employee’s tax liability and is considered compensation for services that is taxable as gross income to the employee.
  • Deduction: The employer may deduct the amount of the employer pick-up as an ordinary and necessary business expense under § 162.
  • Gross Income and Wages: The amount of the employer pick-up is included in the employee’s gross income under section 61 and is also included as wages for federal employment tax purposes under §§ 3121(a), 3306(b), and 3401(a). The employer must report this amount on the employee’s Form W-2.
  • Employee Deduction: The employee can also deduct the employer pick-up as a state income tax under Section 164(a)(3), subject to the same limitations (itemized deductions, SALT cap) as other state income taxes.
  • Relevant Authority: Old Colony Trust Co. v. Commissioner, 279 U.S. 716, 729 (1929); Rev. Rul. 86-14, 1986-1 C.B. 304

Detailed Tax Treatment of Benefits

The ruling also specifies how benefits paid out by the PFML program should be treated:

• Family Leave Benefits:
  • Gross Income: Family leave benefits are fully included in the employee’s gross income under Section 61. This is because family leave benefits may be paid for reasons unrelated to the employee’s own health. There is no exclusion under Section 104(a)(3) for family leave benefits.
  • Not Wages: These benefits are not considered wages for federal employment tax purposes under §§ 3121(a), 3306(b), and 3401(a).
  • Reporting: The state is required to report family leave benefits on Form 1099 if the payments aggregate $600 or more in any taxable year.
  • Reasoning: Family leave benefits are not designed to address an employee’s personal injury or sickness and are more analogous to social security benefits which are partially included in gross income under § 86, but not considered to have been paid as remuneration from employment.
  • Relevant Authority: Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955)
• Medical Leave Benefits:
  • Gross Income: The tax treatment of medical leave benefits depends on whether the benefit is attributable to employer or employee contributions.
    • Employer-Attributable Portion: The portion of the medical leave benefit that is attributable to the employer’s contributions is included in the employee’s gross income under Section 105.
    • Employee-Attributable Portion: The portion of the medical leave benefit that is attributable to the employee’s contributions is excluded from the employee’s gross income under Section 104(a)(3). This exclusion is similar to the exclusion of payments received under accident or health insurance.
  • Wage Treatment: The amount of medical leave benefits that is includible in the employee’s Federal gross income under section 105 is also considered wages for Federal employment tax purposes under §§ 3121(a) and 3306(b).
  • Third-Party Sick Pay: Medical leave benefits attributable to employer contributions are treated as third-party payments of sick pay under Section 3402(o). As such, the state (not the employer) is responsible for meeting the withholding and reporting requirements applicable to third-party sick pay, unless the state is an agent of the employer.
  • Reporting: States must follow the employment tax and reporting requirements applicable to such payments under § 32.1.
  • Reasoning: Medical leave benefits are paid when an employee’s own health condition requires them to take time off of work, making them like the sickness and disability benefits addressed in prior guidance. For this purpose, the state program can be treated as two separate programs -- one providing only family leave benefits and one providing only medical leave benefits. The portion of the medical leave benefits attributable to employer contributions is taxable under § 105, but the portion attributable to employee contributions is excluded under § 104(a)(3). These amounts are determined using the same ratio of employer contributions to total contributions.
  • Relevant Authority: Rev. Rul. 72-191, 1972-1 C.B. 45; Rev. Rul. 75-479, 1975-2 C.B. 44; § 1.105-1(d)(1); Notice 2015-6, 2015-5 I.R.B. 412

Transition Relief for 2025

Rev. Rul. 2025-4 includes a transition period for calendar year 2025. This is to give states and employers time to update their systems and procedures. The transition relief is as follows:

• Medical Leave Benefits Withholding and Reporting: States and employers are not required to follow the income tax withholding and reporting rules for third-party sick pay for the portion of medical leave benefits attributable to employer contributions in 2025. This means that, for 2025, states and employers will not be liable for associated penalties under §§ 6721 or 6722.
• FICA and FUTA Taxes: For 2025, states and employers do not need to comply with § 32.1 and related Code sections regarding FICA and FUTA taxes on medical leave benefits attributable to employer contributions.
• Employer Pick-Ups: For 2025, employers are not required to treat voluntary pick-ups of employee contributions as wages for federal employment tax purposes. This is temporary relief; the general rule will apply to future tax years.

Impact on Previous Guidance

Rev. Rul. 2025-4 amplifies several prior revenue rulings, including:

• Rev. Rul. 81-191, 1981-2 C.B. 49 (Rhode Island),
• Rev. Rul. 81-192, 1981-2 C.B. 50 (New York),
• Rev. Rul. 81-193, 1981-2 C.B. 52 (New Jersey), and
• Rev. Rul. 81-194, 1981-2 C.B. 54 (California) These rulings dealt with state disability benefit programs, and Rev. Rul. 2025-4 expands on their holdings regarding tax treatment of both employer and employee contributions.

Rev. Rul. 2025-4 also modifies Rev. Rul. 72-191. It modifies the holding to specify that mandatory employer contributions are excluded from employee gross income as payments of the employer’s own tax obligation (not as employer-provided coverage under an accident or health plan). It also specifies that employer payments of employee contributions are not excluded from the employee’s income.

Summary Tables

The revenue ruling concludes with two summary tables that outline the Federal income tax consequences of state PFML programs:

• Table 1: Tax Consequences of Contributions This table summarizes the tax treatment of employer contributions, employee contributions, and employer pick-ups of employee contributions.
• Table 2: Tax Consequences of Benefits This table summarizes the tax treatment of both family and medical leave benefits, explaining which amounts are included in gross income and whether they are considered wages.

Prepared with the assistance of NotebookLM.

You can download Revenue Ruling 2025-4 at the following link: https://www.irs.gov/pub/irs-drop/rr-25-04.pdf