UPDATE: In guidance issued on September 24, 2018, IRS resolved the ambiguity in Code section 45S that a previous version of this article discussed. Be sure to read our analysis of that IRS guidance here.
The recently codified Tax Cuts and Jobs Act added section 45S to the Internal Revenue Code (Code), which allows employers to claim a tax credit for providing paid family and medical leave to certain employees. Albeit brief, the statute is quite complicated. There are both all-or-nothing gateway qualification criteria as well as limitations to apply when calculating the amount of the tax credit.
The complicated nature of the statute means there’s good news and bad news, yet no one seems to be talking about either one. The “good” news is that it is possible to count paid time off (PTO) and both insured and self-insured short-term disability (STD) leave, if they are properly structured and coordinated with a formal paid family and medical leave policy. The bad news is that employers are not eligible for the tax credit if paid family and medical leave is not extended to part-time employees.
An employer can only claim this tax credit if it has a written policy that specifically states that it provides the following:
Two weeks of paid leave to employees expected to work 30 hours per week or more.
A proportionate amount of leave to employees expected to work less than 30 hours per week.
A paid leave benefit of no less than 50% of normal wages—a minimum threshold that is not reduced proportionately for part-time employees.
“Wait, what?” you say. Yeah, that’s what we said. Let’s break these down a bit.
Two Weeks Paid Leave to Full-Time Employees
At first glance, this seems pretty straightforward. Either the policy provides employees working 30+ hours per week two weeks of paid leave for FMLA-qualifying purposes or it doesn’t. But when it comes to FMLA leave, it’s not that simple. Most employers take advantage of a leave substitution provision in the FMLA. Under that provision, employers can designate paid leave as FMLA leave so that employees aren’t taking 12 weeks of unpaid leave in addition to paid leave the employer is already providing. So if an employer is already providing paid leave for FMLA-qualifying purposes—such as by designating PTO or STD benefits as substitutes for unpaid FMLA leave—will that FMLA-designated, substituted paid leave count for purposes of the tax credit?
Key Point #1: The Statute Is Ambiguous, but IRS Resolved the Ambiguity
Much of what has been written to date on the paid leave tax credit (mostly on law firm blogs or "blawgs" and in CPA newsletters) assumes or expressly states that PTO and STD must be excluded for purposes of the tax credit. Before IRS issued its guidance, that was one possible way to interpret an ambiguous statute, but IRS later resolved the ambiguity and created a roadmap for employers to count PTO and STD for purposes of the tax credit. (See our analysis of the roadmap IRS created here.)
Proportionate Paid Leave to Part-Time Employees
To be eligible for the Code section 45S tax credit, an employer must provide a minimum amount of paid FMLA leave to employees expected to work less than 30 hours per week, which brings us to ...
Key Point #2: Part-Time Paid Leave Is Required
This is all-or-nothing. An employer claiming a tax credit under Code section 45S must state in its written policy that paid FMLA leave is available to both part-time and full-time employees. If an employer provides paid FMLA leave to full-time employees but not to part-time employees, it is totally ineligible for the tax credit, and it cannot claim a tax credit event for paid leave it provides its full-time employees. No ambiguity to work with on this one.
The number of weeks of paid FMLA leave to which part-time employees must be entitled is proportionate to the number of weeks the employer provides to full-time employees using expected hours per week as the prorating factor. The statute establishes 30 hours per week as the dividing line between part-time and full-time employees. The minimum amount of paid leave benefit (50% of wages) is not prorated for part-timers on FMLA leave.
For example, if an employer offers full-time employees five weeks of paid leave at 100% of wages, then it must provide an employee working 20 hours per week at least 3-1/2 weeks of paid leave or else the tax credit is lost entirely. The percentage of wages paid to this part-time employee conceivably could be less than that for full-time employees, but the benefit cannot be less than 50% of wages or else the employer will be completely ineligible for the tax credit.
Methodology for Calculating the Tax Credit
Only after the gateway qualification criteria are met can you start down the road of actually calculating the tax credit. As tax credits go, it’s not that bad, but there are still at least five steps. Just like the qualification criteria, we’ve analyzed the snot out of the statute to determine how the tax credit is calculated. We’ve written an analyst report on it, and if you’d like to receive a copy, just ping us on the little blue messenger or give us a call.