IRS provides guidance on state paid family and medical leave (PFML) programs

What happened?

The IRS on January 15 published Rev. Rul. 2025-4, which addresses the federal income and employment tax treatment of contributions and benefits paid under state paid family and medical leave (state PFML) statutes. The IRS also outlines the related reporting requirements for employers that participate in state PFML programs. The six scenarios described in the guidance compare different types of state programs to contrast the tax consequences to employers and employee recipients for these contributions and associated benefits.

Why is it relevant?

Rev. Rul. 2025-4 clarifies the disparate tax treatment of state PFML programs based on the nuances in how the programs are administered. Before the issuance of this long-awaited guidance, there was uncertainty regarding the federal employment tax treatment of contributions to these state insurance programs as well as benefits paid to employee participants. For many years, the IRS Priority Guidance Plan included this guidance on contributions to and benefits from PFML programs. In the interim, 13 states, including California, Colorado, Connecticut, Delaware, Maine, Massachusetts, Maryland, Minnesota, New Jersey, New York, Oregon, Rhode Island, and Washington, enacted PFML laws. Effective for tax years after December 31, 2025, this guidance provides clarity on the impact of employees in jurisdictions that maintain a state PFML program. 

Action to consider

As hybrid and remote work continues to be widespread, employers should determine where they have employees performing services to take into consideration those states that have state PFML requirements. Where employers are making contributions, facilitating employee contributions, or have set up comparable private insurance to state insurance programs, consideration should be given to the current position on federal employment tax treatment. 

Employers should compare their current position with the new guidance to evaluate compliance with the new rules. Although the guidance is not effective until 2026, companies should consider the impact of the clarifying rules on the federal payroll tax treatment of contributions and benefits. Additionally, employers should consider how these rules may apply to private plans, and whether there are additional scenarios they want to highlight to the IRS during the comment period, which ends on April 15.

Federal income and employment taxes 

Certain federal employment taxes are imposed on “wages” for services performed in an employment relationship. Federal employment taxes generally include federal income tax withholding as well as Social Security, Medicare, and Additional Medicare (collectively, FICA) taxes and federal unemployment (FUTA). Absent an exception, employers generally are obligated to deduct and withhold and/or remit federal employment taxes on wages they pay. One exception includes unique rules that apply to contributions to and benefits received through an accident or health insurance program (“sick pay”).

Amounts received through accident or health insurance arrangements for an employee’s personal illness or injury are taxable wages to the extent the premiums are paid by the employer under Section 105(a). Further, benefits attributable to the employer contributions are taxable only for FICA and FUTA purposes for the first six months of coverage under Section 3121(a)(4) and 3306(b)(4). Employee contributions to an accident or health insurance plan also may be treated as nontaxable (pretax) when made through a cafeteria plan.

State PFML programs

Many states enacted PFML statutes that mirror the Family and Medical Leave Act of 1993. These programs typically are designed to be state insurance systems funded by payroll taxes. These programs vary significantly in terms of (1) whether the employer and/or employee is required to make contributions, (2) whether employers may elect to use private insurance in lieu of the state insurance system, and (3) how the program is administered. To fund these systems, states may impose contribution requirements through (1) an employer-only tax, (2) an employee-only tax, (3) taxes imposed on both the employer and employee, or (4) an employer-tax that may be elected to be deducted from employee compensation.

Unlike sick pay, state PFML programs often provide benefits in connection with an event other than the employee’s illness or injury, which can change the tax treatment of contributions to and benefits from the program. There is no specific federal income or FICA wage exclusion for PFML contributions or benefits.

After California instituted its PFML program in 2004, the IRS released Chief Counsel Advisory (CCA) 200630017, which provided important but narrowly applicable insights. The CCA was focused on whether the employees could claim a deduction for contributions under Section 164, but the inference was that the contributions were after-tax. The IRS concluded at the time that the benefits paid under the California PFML system, funded only by mandatory employee contributions, are included in the employee’s gross income under Section 85. Questions remained regarding PFML benefits paid by a private insurance company or employer self-insured plan. 

New guidance

Rev. Rul. 2025-4 outlines several conclusions on the federal employment tax treatment of contributions to state PFML programs, including: 

• Employee contributions and employer payment of employee contributions to state PFML programs are included in taxable wages on Form W-2 (i.e., must be made “after-tax”).
• Mandatory employer contributions are excluded from taxable wages. 
• State-paid family leave benefits are included in employee gross income if attributable to (1) employer contributions not previously included in employee’s gross income, (2) employee contributions, or (3) employer payment of employee contributions on their behalf. Such benefits are not taxable wages and are reported on Form 1099.
• Medical leave benefits attributable to employer contributions not previously included in the employee’s gross income are included in employee taxable wages on Form W-2 unless otherwise excluded under Section 105. Employee contributions and employer payments on employee’s behalf are excluded from employee’s gross income. 

Notably, the guidance did not address the tax treatment of private PFML programs that may be used in certain states in lieu of state contributions. There also is a sick pay reporting regime that applies to medical leave benefits that may be impacted and should be analyzed to determine applicability.

In addition to federal employment tax considerations, the IRS also weighed in on the impact to deductions. For example, mandatory contributions by an employer to state PFML programs are deductible as an excise tax under Section 164, whereas employer payment of employee contributions is an ordinary and necessary business expense under Section 162.

The IRS provided transition relief from certain federal withholding, payment, and information reporting requirements for state PFML benefits paid made during calendar year 2025.

Observation: This transition relief will be welcomed by taxpayers that need to analyze their state footprint and assess changes to existing payroll procedures.

This guidance will impact the District of Columbia and states administering paid family and medical leave programs, employers and workers contributing to such programs, and those who receive payments from these programs.

The IRS requested comments on additional situations and state PFML programs by April 15.