The Paid Family and Medical Leave Credit: A Valuable Tax Break for Employers
Many small business owners want to offer better benefits to attract and retain employees, but paid leave can feel expensive. That is where the federal Paid Family and Medical Leave (PFML) credit can help. Under Internal Revenue Code Section 45S, eligible employers may claim a general business credit for providing paid family and medical leave to qualifying employees.
This credit has gone through several extensions since it was first enacted, and it is now permanent beginning in 2026. That matters because employers now have a long-term planning tool instead of a short-lived tax incentive. For businesses that want to support employees while also managing tax costs, the PFML credit can be a meaningful part of their overall compensation strategy.
A Brief History of the Credit
The Paid Family and Medical Leave credit was created by the Tax Cuts and Jobs Act in 2017 as a temporary provision. At first, it applied only to wages paid in 2018 and 2019. Congress then extended it through 2020, and later through 2025.
The biggest change came with the One Big Beautiful Bill Act (OBBBA), which made the credit permanent beginning in 2026. The law also expanded the credit in important ways, including a new option for employers to claim the credit based on insurance premiums paid for PFML coverage rather than only on wages paid during leave.
In practical terms, this moved the credit from a temporary incentive to a long-term planning opportunity.
What the Credit Is Designed to Do
The PFML credit rewards employers that provide paid leave for their employees for certain family and medical situations. It is intended to encourage businesses to offer paid time off when employees need to care for a new child, a seriously ill family member, or their own serious health condition.
The credit is available to eligible employers that provide paid family and medical leave under a written policy and meet certain requirements. It can also apply when an employer pays premiums for insurance that provides PFML coverage.
This is important because the credit is not just about kindness or employee morale. It can be part of a deliberate tax and compensation strategy for the business. An employer that does not offer paid leave will not be subject to any federal penalties for failing to do so, but of course, won’t be eligible for the tax credit.
How the Credit Works
The PFML credit is one of the dozens of credits that are included in the General Business Credit. For wages paid during qualifying leave, the PFML credit is generally between 12.5% and 25% of eligible wages, depending on how much of the employee’s normal wages the employer pays during leave.
The basic framework is simple:
If the employer pays at least 50% of normal wages during leave, the credit begins at 12.5%.
The credit increases by 0.25 percentage points for each percentage point above 50% of normal pay, up to a maximum credit rate of 25%.
The credit can apply to wages paid for up to 12 weeks of leave for a qualifying employee during the tax year.
For example, if an employer pays 70% of normal wages during leave, the credit percentage is higher than if the employer pays only 50%. The more generous the paid leave arrangement, the larger the credit, up to the cap.
Who Counts as a Qualifying Employee?
To claim the credit, the employer must pay leave to a qualifying employee. Under the newer rules, a qualifying employee must generally have worked for the employer for at least one year, although the employer can elect a shorter six-month service requirement.
The law also now clarifies that the employee must customarily work at least 20 hours per week. In addition, the employee’s compensation for the preceding year must not exceed 60% of the highly-compensated-employee threshold for that year, which for 2026 is $96,000 (60% of $160,000, threshold amount).
Thus, the credit is generally not available to executives or top earners. In fact, it is often more relevant to rank-and-file employees whose compensation falls below the highly compensated threshold amount.
What Kinds of Leave Qualify?
Qualifying leave generally includes leave for:
The birth of a child,
Adoption or foster care placement,
Care for a spouse, child, or parent with a serious health condition,
The employee’s own serious health condition,
Certain military-related exigencies, and
Care for a covered servicemember with a serious injury or illness.
This makes the credit especially useful for businesses trying to create a more flexible and supportive workplace without absorbing the full cost of paid leave on their own.
Employers Must Have a PFML Written Policy
To be eligible for the PFML credit, the employer must have a written policy that provides at least two weeks of annual paid family and medical leave for full-time employees and a proportional amount for part-time employees who customarily work at least 20 hours per week.
That written policy is critical. The credit is not automatic just because an employer informally pays an employee while they are out sick. The business needs the policy, the documentation, and the payroll records to support the claim.
The employer must also be careful about coordination with other leave rules. Leave required by state or local law can count toward the eligibility requirements for the credit, but it does not count toward the amount of the credit itself. That distinction matters because many employers operate in states with paid leave mandates.
Wages Method or Premiums Method?
One of the most important enhancements to the credit is that employers may now choose between two calculation methods.
Paid During Leave - Under the traditional method, the employer claims the credit based on wages paid to qualifying employees while they are on family and medical leave.
Insurance Premiums Paid - Under the newer rule, the employer may instead claim the credit based on premiums paid or incurred by the business for an insurance policy that provides paid family and medical leave.
This premium-based method is available even if no qualifying leave is actually taken during the year. That can be especially helpful for employers that ensure the risk rather than fund leave directly out of cash flow.
The amount of the credit claimed when using the premiums-paid method reduces the insurance deduction that the business claims.
The employer must choose between the wage method and the premium method. It is not a double benefit. That makes the planning analysis important, because the better method will depend on the employer’s workforce, benefits design, and cash flow. The method chosen may change from year to year.
What Leave Paid by State or Local Law Means for the Credit
Many employers ask whether state-mandated paid leave affects the federal credit. The answer is yes, but only in a limited way.
State or local leave can be counted in determining whether the employer meets the minimum leave requirements. However, it is not counted in calculating the amount of the federal credit.
So, if your business already provides leave because a state law requires it, you may still be able to qualify for the federal credit, but the state-required leave itself does not increase the federal credit amount.
How to Claim the Credit
Employers claim the PFML credit on their tax return using Form 8994 and Form 3800. Those forms are part of the General Business Credit system, so the credit is not taken on a separate “easy” schedule.
For S corporations, the credit is reported on Schedule K and passed through to shareholders on Schedule K-1. That means the credit affects the entity return and also flows to the owners, just like other General Business Credit items.
Employers should also avoid double counting. Wages used for certain COVID-era employment credits cannot also be used to figure the PFML credit. The same basic no-double-dipping concept applies here that applies to many tax credits: one dollar of wages generally cannot support multiple incentives at once.
Why this Credit Matters for Small Businesses
For many small businesses, the PFML credit can help make paid leave more affordable. It can also support recruiting and retention, especially when labor markets are tight. A well-designed leave policy can be a competitive advantage, not just a compliance burden.
From a tax planning standpoint, the credit may be especially useful when an employer is already considering:
improving employee benefits,
formalizing a written leave policy,
purchasing leave insurance,
aligning benefits across locations or entities, or
reviewing payroll and compensation policies.
In other words, the credit is not just a tax form issue. It is a business planning issue.
Practical Planning Takeaways
Here are the main questions a business owner should ask:
Do we have a written PFML policy?
If not, the credit may not be available.Do our employees meet the service and compensation rules? The employee tests matter just as much as the leave itself.
Should we use the wage method or the premium method? The best answer depends on whether the business directly pays leave or insures it.
Do any state leave laws affect our eligibility? They may count toward eligibility, but not toward the credit amount.
Are we filing the right forms? Form 8994 and Form 3800 are required, and S corporations must properly pass the credit through to the shareholders.
Final Thoughts
The Paid Family and Medical Leave credit has evolved from a temporary benefit into a permanent planning tool beginning in 2026. That alone makes it worth a fresh look. But the newer premium-based method and expanded eligibility rules make it even more flexible for employers.
For business owners, the key point is simple: if you already offer paid leave, or if you are thinking about adding it, the federal credit may help offset the cost. The credit will not solve every compensation or benefits issue, but it can improve the economics of a leave policy while supporting employees during important life events. To accomplish that, it is essential to have a written leave policy.
If you are a business owner, this is a good time to review your leave policy, payroll process, and tax filings with your advisor. The right structure may let you support your team and reduce your tax bill at the same time.
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