As mentioned in our January 2018 Client Advisory, the Tax Cuts and Jobs Act (the “Act”), signed into law at the end of 2017, contains a temporary employer tax credit, ranging from 12.5 percent to 25 percent, that may be claimed by eligible employers for certain wages paid to qualifying employees during family and medical leave, pursuant to a written policy and subject to certain maximums and other limitations. This advisory explores some of the limitations of the new tax credit, highlighting issues employers should consider pending the issuance of additional guidance explaining and interpreting the Act’s provisions.
Eligibility Requirements. The tax credit is available to eligible employers regardless of whether they are covered by the Family and Medical Leave Act of 1993, as amended (“FMLA”), but to be eligible for the tax credit, employers’ policies must provide FMLA-like protections to their employees. That is, such employers must ensure that the employer will not interfere with the exercise of rights under the policy or discriminate against individuals opposing any practice prohibited by the policy. Furthermore, an employer must provide both full-time and part-time employees a minimum amount of annual paid family and medical leave at a rate not less than 50 percent of regular wages.
Worthwhile? In evaluating whether the potential tax credit is worth complying with the Act’s numerous requirements, employers should consider the costs and benefits of doing so. For example, for employers who pay 100 percent of regular wages during the leave, the credit is subject to a 25 percent cap; employers who pay 50 percent of regular wages are eligible for a 12.5 percent credit. The amount of credit allowed with respect to any employee is also subject to a cap based on such employee’s normal hourly wage rate for each hour of actual service performed for the employer and the number of hours for which family and medical leave is taken. In addition, the credit only applies to wages paid to employees who are employed for at least one year and who earn no more than 60 percent of the highly compensated employee limit for the preceding year (the limit is $120,000 for 2017 and 2018).
As noted above, an employer must provide a minimum required amount of paid family and medical leave to both full-time and part-time employees. The minimum required amount is two weeks for full-time employees and a commensurate pro-rata amount for part-time employees based on the number of hours they are expected to work. Considering that most paid leave policies cover only full-time employees, employers should also evaluate the pros and cons of expanding coverage to part-time employees.
Furthermore, employers should consider that the tax credit does not apply to:
- Paid vacation leave, personal leave, or medical or sick leave (other than FMLA leave).
- Leave paid by state or local government or required under state or local laws.
- Leave that is not paid pursuant to a qualifying written policy.
- Paid family and medical leave in excess of 12 weeks for any taxable year.
- Wages in tax years beginning after 2019 (i.e., it is a temporary tax credit).
Considering the potential costs of complying with the tax credit’s eligibility requirements and its limited application, it may be more advantageous in some cases for an employer to treat paid leave as an ordinary and necessary business expense (i.e., a deduction). Accordingly, employers should consult their tax advisors to determine whether the deduction would be more advantageous than the tax credit.
Open Issues. As the IRS has yet to release guidance, there are still a number of uncertainties regarding how the law applies, including for example:
- How should employers, especially those with generous leave policies, distinguish and document payments made for purposes of “medical or sick leave” from payments made for similar forms of leave under FMLA? One reasonable interpretation would be that the credit does not apply to medical or sick leave paid for circumstances that would not qualify as FMLA leave, such as a medical condition which is not a serious health condition, injury or illness.
- Can the credit apply to payments made during family and medical leave required by state or local law if such law only requires job protected unpaid leave? As the purpose of the credit is to incentivize employers to provide paid family and medical leave, it seems reasonable that the credit would apply to payments for qualifying family and medical leave where state or local law only requires unpaid leave.
- How do employers determine the hourly wage rate for non-hourly wage earners for purposes of calculating the maximum potential credit? The Act indicates that wages of non-hourly wage earners are to be prorated under regulations established by the IRS, but such regulations are not yet available.
- For purposes of calculating the maximum potential credit, how do employers determine hours of actual services performed by an employee? The Act does not indicate that additional regulations on this point are forthcoming, but we would hope some form of guidance will be released by the IRS.
- What constitutes a taxable year for purposes of the tax credit’s 12-week paid family and medical leave limit? Generally, a taxpayer may use a calendar year or a fiscal year as its taxable year, unless a tax year is otherwise required by the IRS.
IRS guidance is needed to confirm or clarify the above.
Because the tax credit is limited to wages paid through 2019 and given the uncertainties regarding the Act’s application, we expect that those employers with established FMLA programs may find the new tax credit most useful.
If you have any questions or compliance concerns, please contact our Employee Benefits group.