Paid Family and Medical Leave Credit 2026: What Employers Should Review

How the Paid Family and Medical Leave Credit 2026 Changed

Section 45S provides a federal general business credit to eligible employers that provide qualifying paid family and medical leave.

For tax years beginning after December 31, 2025, the credit was made permanent and expanded.

One of the biggest changes is the premium method. An employer that maintains a paid family and medical leave insurance policy may be able to calculate the credit using qualifying premiums paid or incurred for that coverage. The wage method, based on qualifying wages paid during leave, is still available.

For the wage method, the credit generally ranges from 12.5% to 25%, depending on the level of wage replacement, and generally applies to no more than 12 weeks of qualifying leave for an employee during the tax year.

The 2026 rules also changed employee eligibility and how certain state or local leave is considered.

You can review the IRS overview of the 2026 Section 45S guidance.

Mistake 1: Assuming Any Paid Leave Policy Qualifies

A company can offer generous PTO and still not have a Section 45S policy.

The credit is tied to qualifying paid family and medical leave, not simply time away from work with pay.

An eligible employer generally needs a written policy that provides qualifying full-time employees at least two weeks of annual paid family and medical leave, with a prorated amount for qualifying part-time employees. The policy also generally must provide at least 50% of the wages normally paid to the employee.

The policy may also need specific non-interference protections for qualifying employees who are not covered by Title I of the Family and Medical Leave Act.

Start by reading the policy.

Look at the reasons for leave, who can use it, how much leave is available, and how much pay the employee receives.

Vacation, general PTO, personal leave, and ordinary sick leave do not automatically qualify.

Mistake 2: Using the Wrong Credit Method

For 2026, employers may have another choice to make.

Is the benefit funded through wages paid directly by the employer, through a paid family and medical leave insurance policy, or through both?

Under the wage method, the credit is based on qualifying wages paid to an employee while that employee is on qualifying family and medical leave.

Under the premium method, only the portion of the premium that funds creditable paid family and medical leave coverage can be used.

A premium is not creditable to the extent it funds nonqualifying leave, coverage for nonqualifying employees, leave required by state or local law, leave paid for by a state or local government, or benefits that would not be qualifying wages for Section 45S purposes.

If one premium covers both qualifying and nonqualifying benefits, the employer needs to allocate it.

The allocation should use objective criteria, match the policy terms, be supported by contemporaneous records, and be applied consistently.

Current IRS guidance also allows an employer to use the wage method for some leave and the premium method for other leave.

What you cannot do is claim both methods for the same funded benefit.

If a premium funded the benefit and the employer claimed a credit for that premium, the same benefit cannot also be used for the wage credit.

Notice 2026-28 provides current reliance guidance on the premium method, state leave treatment, controlled groups, and related 2026 rules.

Mistake 3: Overlooking the 2026 Employee Eligibility Rules

The employee rules deserve a fresh look in 2026.

A qualifying employee generally must customarily work at least 20 hours per week. Employers may also elect to use a six-month employment period instead of the one-year employment period.

But do not stop there.

A qualifying employee must also meet the applicable compensation limit, which looks to compensation from the preceding year. That means prior-year payroll records may need to be reviewed.

Review the service period, weekly hours, compensation limit, and coverage under the written policy. If the policy was drafted around the older rules, make sure it still matches how the business plans to claim the credit.

Mistake 4: Misunderstanding State and Local Paid Leave

This is one of the easier 2026 changes to misread.

Certain leave required by state or local law, or paid for by a state or local government, can now be taken into account when determining whether an employer provides enough paid family and medical leave to qualify as an eligible employer.

Think of the state or local leave rule as part of the eligibility review, not an amount that automatically increases the Section 45S calculation.

Separate what the employer provides voluntarily from what state or local law requires or a government program pays.

Mistake 5: Forgetting the Deduction Adjustment

Tax credits and deductions often interact. Section 45S is no exception.

If the employer claims a wage-based Section 45S credit, the deduction for wages or salaries generally must be reduced by the amount of the credit.

A similar rule applies to the premium method. The deduction for qualifying insurance premiums is generally reduced by the premium-based credit claimed.

Payroll records, benefit records, the credit calculation, and the related deductions should agree.

If your business is reviewing several employer incentives, it also helps to keep the difference between tax deductions and tax credits clear before the return is finalized.

Mistake 6: Ignoring Related Employers and Controlled Groups

A business with related companies should not assume each entity gets to review Section 45S in isolation.

The 2026 aggregation rules generally treat certain businesses under the Section 414(b) and 414(c) controlled-group rules as a single employer.

There is a limited exception when a business can establish a substantial and legitimate business reason for not providing the required written policy. I would not assume it applies without looking closely at the facts.

If related companies have different policies, benefit providers, or employee groups, line those differences up before one entity claims the credit.

Wage Method or Premium Method: Which One Fits Your Leave Program?

If your company pays employees directly while they are on qualifying leave, the wage method may be the natural starting point.

If the company pays premiums for an insurance policy that funds qualifying paid family and medical leave, the premium method may be worth reviewing.

Some employers may use both methods in the same year for different leave.

The key question is: Who funded this benefit?

If part came from insurance and part came directly from the employer, the credit calculation needs to follow that funding.

Do not use the full insurance invoice just because the policy includes paid leave. If the premium covers other benefits or nonqualifying employees, identify the creditable portion first.

What Employers Should Review Before Claiming the Credit

Before calculating anything, pull the pieces together.

Review:

• The written leave policy and effective date
• Which family and medical leave reasons are covered
• How much leave is available
• The percentage of normal wages replaced
• Employee service periods
• Customary weekly hours
• The applicable employee compensation limit
• Part-time employee treatment
• Wages paid during qualifying leave
• Paid family and medical leave insurance premiums
• Any blended premium allocation
• State and local mandated leave
• Government-paid leave
• Related employers or controlled groups
• The wage or premium deduction adjustment
• Prior Section 45S claims

The form should come after this review, not before it.

Records to Keep for the Paid Leave Credit

Keep the written policy, effective dates, employee eligibility records, leave dates, payroll reports, wage-replacement calculations, and records showing why the leave was treated as qualifying.

If insurance is involved, keep the policy, benefit description, premium invoices, and calculations used to separate creditable coverage from other coverage.

For a blended premium, document the allocation method while the information is available. It should be based on objective information and applied consistently.

Multi-state employers should also keep records showing which benefits were required by state or local law and which benefits were voluntarily provided.

How Employers Claim the Section 45S Credit

Form 8994 is used to calculate the employer credit for paid family and medical leave. The credit is part of the general business credit and may also flow through Form 3800, depending on the taxpayer and return.

Do not treat Form 8994 as the eligibility test.

The policy, employee rules, funding, state-leave treatment, and deduction adjustment need to be settled first.

Notice 2026-28 provides current reliance guidance while Treasury and the IRS work on proposed regulations. Employers should use the final current-year Form 8994, instructions, and other guidance available when the return is filed.

What to Do Next

If your business offers paid family or medical leave, pull the policy before tax preparation gets too far along.

Then ask three practical questions:

• Who qualifies under the policy?
• How is the benefit funded?
• Which part of the benefit actually fits Section 45S?

From there, review the wages, premiums, state or local requirements, employee compensation limits, and any related businesses.

Employers reviewing other benefit-related incentives may also want to look separately at the employer-provided childcare credit. It is a different credit with different requirements.

The goal is not to chase a credit because it sounds available.

The goal is to know whether your business qualifies, calculate it correctly, and have the records to support it.

IRSProb’s guide to tax planning tips for 2026 may also help when comparing benefit-related incentives.

FAQs About the Paid Family and Medical Leave Credit 2026

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