IRS Guidance Clarifies Employer Paid Leave Tax Credit Rules for 2026

The IRS and Treasury have issued interim guidance on the employer credit for paid family and medical leave under Section 45S, a provision that was made permanent and expanded in the 2025 budget law. The guidance matters now because several of the key changes apply for tax years beginning after December 31, 2025, including a new way to compute the credit using insurance premiums instead of wages paid during leave.

The notice gives employers more clarity on who qualifies, what leave counts, and how to avoid double counting. It also confirms that taxpayers may rely on Notice 2026-28 until proposed regulations are issued, according to Ogletree Deakins, while Accounting Today reported that Treasury and the IRS are seeking comments through October 16, 2026.

What Changed

Section 45S was originally enacted in 2017 as a temporary credit for employers that voluntarily provide paid family and medical leave. The 2025 law made the credit permanent and expanded it for tax years beginning after 2025.

The biggest addition is the new premium method. Before, the credit was based on wages paid to qualifying employees while they were on leave. Beginning in 2026, employers that maintain a paid leave insurance policy may instead calculate the credit based on qualifying premiums paid or incurred during the year.

The guidance says the premium method is limited to coverage that would have qualified under the wage method. In practice, that means premiums tied to nonqualifying leave, nonqualifying employees, state- or locally required leave, or benefits that would not count as wages are excluded. JD Supra reported that the notice calls this limiting concept “creditable coverage.”

The notice also allows employers to use both methods in the same year, but not for the same instance of leave. If a benefit is partly funded by insurance and partly by the employer’s general assets, the employer may use the premium method for the insured portion and the wage method for the rest.

Who Is Affected

The credit is available to employers of all sizes. Ogletree Deakins said there is no employer-size threshold, and an employer does not need to be subject to the federal Family and Medical Leave Act to qualify.

To be eligible, an employer must have a written paid leave policy that meets three basic conditions:

• at least two weeks of annual paid family and medical leave for full-time qualifying employees, with a proportionate amount for part-time employees;
• pay of at least 50% of the employee’s normal wages, excluding overtime and discretionary bonuses; and
• language protecting employees against interference with or retaliation for exercising FMLA rights under the policy.

Beginning in 2026, a qualifying employee generally must have at least one year of service, although the employer may choose a six-month threshold instead. The employee also must have earned no more than $96,000 in the prior year, or 60% of the highly compensated employee threshold under federal law, and must customarily work at least 20 hours per week.

The leave itself must be for FMLA-type purposes, such as the birth or adoption of a child, the employee’s own serious health condition, caring for a spouse, child, or parent with a serious health condition, qualifying military exigencies, or caring for a covered servicemember. General vacation, personal leave, or undifferentiated sick leave does not qualify.

One practical change for multistate employers is the treatment of state and local leave mandates. For tax years beginning after 2025, leave required by state or local law can count toward meeting the federal minimum leave requirement, but it still cannot be used in calculating the credit amount.

The After-Tax Math

Under the wage method, the credit starts at 12.5% of qualifying leave wages when the employer pays 50% of normal wages during leave. The percentage rises by 0.25 percentage points for each percentage point above 50%, topping out at 25% when the employer pays 100% of normal wages.

Example: if an employer pays a qualifying employee 75% of normal wages during covered leave, the applicable credit percentage is 18.75%. On $3,000 of qualifying leave wages, the credit would be $562.50, as Ogletree Deakins noted.

The statute also caps the amount of wages that can be taken into account. Per employee, counted wages cannot exceed the employee’s normal hourly wage multiplied by the hours of leave taken, and no more than 12 weeks of leave per employee per year may be used.

There is also a deduction tradeoff. Section 280C(a) requires an employer claiming the credit to reduce its wage deduction by the amount of the credit. Accounting Today reported that employers also cannot deduct the portion of premiums or wages equal to the credit claimed. In addition, wages used for the Section 45S credit cannot be used for other payroll-based tax credits.

What Employers May Want To Review

The guidance is especially relevant for employers that fund leave through insurance or operate in states with paid leave mandates. For insured arrangements, the notice requires a reasonable, consistent, and well-documented method for allocating blended premiums when a policy covers both creditable and noncreditable benefits.

Households that own closely held businesses, as well as executives involved in finance or compensation decisions, may want to watch how companies handle four items before 2026 tax years begin:

• whether the written leave policy satisfies the two-week, 50% pay, and noninterference requirements;
• whether the employer will use the one-year service rule or elect the six-month threshold;
• how qualifying employees will be identified under the $96,000 prior-year pay cap and 20-hours-per-week test; and
• how records will track leave funded by insurance versus leave funded directly by the employer.

The credit is claimed on IRS Form 8994.

What To Watch Next

This guidance is interim, not the final word. Treasury and the IRS said proposed regulations are forthcoming, and taxpayers may rely on the notice until those rules are issued.

Accounting Today reported that the agencies are requesting comments on several unresolved areas, including methods for allocating blended premiums, the treatment of voluntary state programs administered by private insurers, and what counts as a substantial and legitimate business reason under the aggregation-rule exception. Comments are due by October 16, 2026.

For employers, the open questions are less about whether the credit exists and more about how administrable it will be in real-world leave programs. The answer could determine whether the new premium method becomes a useful simplification or another compliance project worth discussing with tax advisors and benefits counsel.

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