Tax Incentive for Paid Family Medical Leave May Alleviate FMLA Benefit Complications

by Carlton Fields
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Not only does the Tax Cuts and Jobs Act contain a tax incentive to promote the offering of paid family medical leave (FML), but it creates a lower-cost way to eliminate common complications that arise when employees are unable to continue paying health plan premiums while on unpaid leave.

Tax Incentive. Specifically, newly created IRC 45S provides a tax credit for employers with an eligible paid FML policy. Generally, the policy must provide for payment of at least 50 percent of employees’ regular rates of pay for at least two weeks. Employers satisfying this minimum threshold are not only entitled to a tax deduction for the compensation paid, but are also entitled to a tax credit on the first 12.5 percent paid. The following table outlines how employers can structure their policies for this and even higher credits, up to 25 percent of the amounts paid out as compensation.

IRC 45S Full Pay
(per 2 weeks)
FML Pay
(for 2 weeks)
Tax Credit Tax Deduction
12.5% credit for FML paid leave, as long as pay rate is at least 50% regular pay $2,000 $1,000 (50%) $125 (12.5%) $875
Every 1% increase in pay (above 50%) triggers a 0.25% increased credit $2,000 $1,020 (51%) $130.05 (12.75%) $889.95
Maximum credit is 25% $2,000 $1,500 (75%) $375 (25%) $1,125

For example, if a C-corporation’s[1] paid FML policy provided for an employee with annual compensation of $60,000 to be paid $7,500 (half-pay) for three months of FML, it would be entitled to a $937.50 tax credit and a $6,562.50 tax deduction (which, at the 21 percent corporate rate, is worth $1,378.13). If that employee received $11,250 (three-quarter pay) for three months of FML, the company would be entitled to a $2,812.50 tax credit and a $8,437.50 tax deduction (which at the 21 percent corporate rate, is worth $1,771.88).

Added “Benefits Bonuses.” Paid FML can alleviate a common issue that arises with unpaid FML. Since the Family Medical Leave Act (FMLA) requires employees on FML to be immediately reinstated for any health insurance coverages lost during FML, employers are often hesitant to cancel insurance coverage – even if employees fail to pay premiums. Since this can be difficult, many employers opt to fully pay for coverage while employees are on unpaid FML, with the expectation (or hope) that employees will repay the employer. If the employees leave employment without repaying those amounts, employers have relatively no practical recourse. With paid FML, employers avoid this issue altogether, and the employer cost is significantly reduced by the tax credit.

It is also common for employees to need more leave than the three months allotted by the FMLA. Think of employees who are exhausting their sick time, vacation time, and FML to care for an ill family member who ultimately dies. The employee may request additional unpaid leave to grieve and get their life in order. This triggers a problem if health insurance plans are drafted to provide that employees on unpaid leave (other than leave under the FMLA) are ineligible for coverage. I normally advise against these eligibility restrictions, but for plans that have this in place, these employees just incurred a COBRA event, and should lose coverage unless a timely COBRA election is made. Here, offering paid FML means employees need not use sick and vacation leave initially, so the likelihood of the employee needing to go on unpaid leave is reduced. This, in turn, reduces an employer’s COBRA obligations, which is always valuable since many COBRA errors can trigger penalties of up to $110/day.

Incentive Restrictions. There are several limits on the use of this benefit. The two most important are that (i) no tax credit is available to the extent the “paid FML” triggers a loss of paid vacation and sick leave for that time; and, no credit is available for paid FML offered to employees earning over 60 percent of the threshold that defines “highly compensated employees” (IRC 414(q)(1)(B)). For 2018, this means that no credit is available for any paid FML leave provided to employees who earned over $72,000 in 2017. Of course, employers are still entitled to a deduction for compensation paid to these individuals while on FML.

Plan Design. In spite of the restrictions, there is enough flexibility in IRC 45S to allow employers to be somewhat creative in designing these programs, such as by partially-basing the level of pay on the amount of insurance premiums normally paid by employees. This may be attractive since as long as compensation is sufficient to pay the employee portion of insurance premiums, employers can require employees on FML to continue making their payments, and can enforce it through payroll deduction, without the employer paying more than it normally does for employees’ coverages.

Conclusion. If your entity wrestles with insurance coverage complications triggered by unpaid FML, it should consider implementing a paid FML policy now. IRC 45S is scheduled to expire on December 31, 2019, but this two-year item may be extended, and I surmise that the more employers utilize the benefit, the more likely it is to be extended.

[1] This example uses a C-corporation, but the tax benefit is available to any type of entity or individual.

This article was updated on February 28, 2018.

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Carlton Fields
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