FMLA Tax Credit: Policy Rules, Deduction Reduction, and Filing

The FMLA tax credit, formally the Section 45S employer credit for paid family and medical leave, gives employers a dollar-for-dollar tax reduction worth 12.5% to 25% of the wages they pay employees who take qualifying leave. The credit was made permanent by the One Big Beautiful Bill Act of 2025, which also added a second way to claim it based on paid-leave insurance premiums rather than actual wages paid.¹ To claim it, an employer needs a written policy meeting specific minimums, employees who fit the qualifying-employee tests, and leave that is tracked to an FMLA purpose.

What the Credit Is Worth

The credit rate scales with how much of an employee’s normal pay the employer covers during leave. At the statutory floor of 50% wage replacement, the credit is 12.5% of the wages paid during leave. Each additional percentage point of wage replacement adds 0.25 percentage points to the credit rate, reaching 25% when the employer covers 100% of normal wages.²

A few points on the scale:

50% wage replacement: 12.5% credit
60% wage replacement: 15% credit
75% wage replacement: 18.75% credit
100% wage replacement: 25% credit

Only the first 12 weeks of leave per employee per tax year feed into the calculation. Anything paid beyond that is still a valid benefit but does not generate additional credit.³

The Written Policy Requirement

No written policy, no credit, no matter how generously an employer actually pays workers who take leave. The policy has to guarantee at least two weeks of paid family and medical leave per year for every qualifying full-time employee, with a proportional amount for part-timers, and it has to promise at least 50% wage replacement during that leave.⁴

If any qualifying employees are not already covered by the federal Family and Medical Leave Act, the written policy must also contain non-interference language: an assurance that the employer will not block leave, punish employees for taking it, or retaliate against complaints about violations. Employers already covered by the FMLA get that protection from federal law and do not have to duplicate it in the policy for FMLA-covered workers.

Which Employees Qualify

A worker on the payroll only counts toward the credit if they meet three tests under the current statute:²

Tenure of at least one year with the employer. Starting in 2026, an employer may elect a lower six-month threshold.
Prior-year compensation no greater than 60% of the highly compensated employee threshold under Section 414(q)(1)(B). For 2026, that threshold is $160,000, putting the qualifying-employee cap at $96,000.
Customary work schedule of at least 20 hours per week.

The compensation cap is a common source of error, because older summaries cited the full highly compensated employee threshold rather than 60% of it. Under the current law, the cutoff is the lower figure, and prior-year compensation should be checked on an annualized basis with proration for part-time workers.

Which Leave Purposes Count

The leave must be taken for one of the reasons recognized under the FMLA. Generic vacation time, personal days, or all-purpose sick leave does not generate a credit, even if an employee uses it for a qualifying reason.³ The qualifying reasons are:

Birth of a child and bonding with a newborn
Adoption or foster placement of a child
Caring for a spouse, child, or parent with a serious health condition
The employee’s own serious health condition
Qualifying exigencies arising from a family member’s active-duty military service
Caring for a seriously injured or ill service member who is a close family member

The policy does not have to cover every category. It just has to pay for leave that falls into at least one of them, and the leave has to be specifically designated in the employer’s records as FMLA-purpose leave. Generic PTO used for a qualifying reason does not count unless it is tracked separately.⁴

State-Mandated Leave Does Not Count

Leave paid by a state or local government, or required to be paid under state or local law, is excluded from the credit base. The employer’s policy has to independently meet the Section 45S minimums using the employer’s own money.⁴

Employers in states with paid-leave mandates are not automatically shut out. If state law requires six weeks of leave but is silent on whether it is paid, an employer who voluntarily pays 50% or more of normal wages during that period can still qualify. The test is whether the payments come from the employer rather than a government fund, and whether they are voluntary rather than legally compelled. Documentation showing where the policy exceeds state minimums is worth keeping.

The Deduction Reduction

Claiming the credit means giving up part of the ordinary wage deduction. Under Section 280C, the employer’s deduction for wages and salaries is reduced by the amount of the Section 45S credit claimed.⁴ The credit is still a net benefit, since it comes off tax owed dollar-for-dollar while the deduction only reduces taxable income, but the same wages cannot do both jobs.

Wages already used to claim another general business credit, such as the Work Opportunity Tax Credit, also drop out of the Section 45S base. No double counting across employment credits.

How to File

The credit is calculated on IRS Form 8994, Employer Credit for Paid Family and Medical Leave, which asks for the number of qualifying employees, the wages paid during leave (or the premiums paid under the new insurance option), and the applicable credit percentage.⁵

The Form 8994 amount then flows to Form 3800, the General Business Credit form, which totals all business credits before carrying them to the income tax return: Form 1120 for corporations, Form 1065 for partnerships, or Schedule C on Form 1040 for sole proprietors.⁶

If the credit exceeds tax owed, the general business credit carryback and carryforward rules apply. The unused portion can typically be carried back one year and forward up to 20 years. If the IRS follows up on a claim, expect requests for the written leave policy, payroll records showing wages paid during leave, and documentation of tenure and prior-year compensation for each qualifying employee. Keeping these records for at least three years after filing is the practical minimum.

What Changed in 2025

Section 45S was originally set to expire for tax years beginning after December 31, 2025. The One Big Beautiful Bill Act of 2025 struck the sunset, making the credit permanent.²

The same law added the insurance-premium alternative. An employer that carries a paid family and medical leave insurance policy can apply the 12.5% to 25% percentage to the premiums paid on that policy during the tax year, rather than to wages actually paid to employees on leave. Under this option, no employee has to have taken leave during the year; what matters is that the policy was in force and would have paid a qualifying benefit. The tenure-election change reducing the one-year requirement to six months at the employer’s option also takes effect in 2026. Because IRS guidance has not yet caught up with all of these changes, the current statutory text should govern when a question comes up mid-filing.

1
U.S. Department of Labor. Paid Leave
2
Office of the Law Revision Counsel. 26 USC 45S – Employer Credit for Paid Family and Medical Leave
3
Office of the Law Revision Counsel. 26 U.S. Code 45S – Employer Credit for Paid Family and Medical Leave
4
Internal Revenue Service. Section 45S Employer Credit for Paid Family and Medical Leave FAQs
5
Internal Revenue Service. About Form 8994, Employer Credit for Paid Family and Medical Leave
6
Internal Revenue Service. Internal Revenue Service Form 3800 – General Business Credit