Compliance FYI: Taxation of State Paid PFML Programs
On January 15, 2025, the Internal Revenue Service (IRS) released Revenue Ruling 2025-4 laying out the tax treatment of various scenarios arising from contributions to and benefits from state paid family and medical leave (PFML) programs.
While exact details of PFML programs vary from state to state, they are generally funded through a combination of employee and employer premiums paid via payroll deduction. In some states, employers may voluntarily cover their employee’s portion of the premium. The IRS refers to this as “employer pick-up.” The contributions are used to establish a PFML fund from which monetary benefits are paid to eligible individuals who apply for benefits.
Previously, it was unclear how payments to and from PFML funds should be treated for federal tax purposes. Revenue Ruling 2025-4 clarifies the IRS’ stance on these contributions and payments and provides guidance moving forward.
The exact tax treatment depends on whether the employer or employee contributed towards PFML premiums and whether any PFML benefits received were the result of family leave or medical leave. Revenue Ruling 2025-4 does not address contributions to or payments received from an equivalent private plan that an employer is using to comply with the state law.
Tax Treatment of PFML Contributions
Revenue Ruling 2024-5 distinguishes between mandatory contributions and “employer pick-up” of an employee’s required contributions. Mandatory contributions are PFML premium contributions that an employer or employee must make by law. An employer pick-up occurs when the employer decides to voluntarily contribute all or a portion of the employee’s PFML premiums as permitted by state law.
Mandatory Employer Contributions
Mandatory employer contributions are considered state excise taxes and are therefore deductible on an employer’s federal taxes. The employer’s mandatory contribution is not considered federal gross income to the employee.
Mandatory Employee Contributions
Mandatory employee contributions are considered state income taxes and can be deducted by the employee on their federal taxes assuming the employee itemizes deductions and is not limited by the State and Local Tax (SALT) deduction limit. The contributions should still be included in the employee’s federal gross income and wages for federal employment tax purposes and the employer should report the amount on the employee’s Form W-2.
Employer Pick-Up Contributions
An employer pick-up covering all or a portion of an employee’s PFML premiums is a deductible business expense for the employer on the employer’s federal taxes. The employer pick-up is considered additional compensation to the employee and is included in the employee’s earnings for federal income tax and federal employment tax purposes. Employees may deduct the voluntary employer contributions as state income tax if they itemize deductions and are not limited by the SALT deduction limit.
Tax Treatment of PFML Benefits
The tax treatment of the benefits from state PFML funds depends on whether the benefit is for medical or family leave and whether the employee or employer was the one to make the required contributions.
Medical Leave
Medical leave benefits attributable to the employee’s contribution are not included in an employee’s federal gross income, are not wages for federal employment taxes purposes, and are not treated as sick pay.
Medical leave benefits attributable to the employer’s contribution are included in an employee’s gross income. These benefits are like disability leave payments for employment tax purposes and third-party payments of sick pay. The state must comply with the employment tax and reporting requirements that otherwise apply to third party payments of sick pay.
The amount of medical leave benefits that are attributable to an employer pickup are not included in an employee’s federal gross income, are not wages for federal employment taxes purposes, and are not treated as sick pay.
Family Leave
Family leave benefits paid to employees are included in their federal gross income but are not wages for federal employment tax purposes. The state must furnish the employee a Form 1099 if the payments aggregate $600 or more in a taxable year.
Effective Date
Revenue Ruling 2025-4 is effective for payments made on or after January 1, 2025. However, calendar year 2025 is viewed by the IRS “as a transition period for purposes of IRS enforcement and administration of the information reporting requirements and other rules described….” Accordingly, states and employers are not required to comply with certain withholding and reporting requirements. Employers would be well served to review this transition period relief with their accountant or tax counsel.
Key Takeaways:
Employers with employees in states with paid family and medical should review the guidance in Revenue Ruling 2025-4 to understand federal tax consequences. Employers may need to discuss the implications of the ruling with their tax advisor. Importantly, Revenue Ruling 2025-4 did not address the tax treatment of PFML benefits provided through an equivalent employer sponsored private plan. Employers using private plans to comply with state PFML laws may want to review the tax treatment of those plans with their accountant or tax counsel.
The information provided is a summary of laws and regulations relating to employee benefit plan compliance. This information should not be construed as legal advice. In all cases, employers should consult with their own legal counsel.
