IRS Blesses Insurance Premium Funded Paid Leave Tax Credit
The 2017 Tax Cuts and Jobs Act (TCJA) created a new federal tax credit for employers who offer qualifying paid family and medical leave.The One Big Beautiful Bill Act (OBBBA) expanded on what was initially a temporary Section 45S credit, making it permanent and significantly more attractive to employers—particularly employers interested in funding the employment benefit with insurance.While the expansion was effective starting January 1, 2026, the IRS has only just recently weighed in with guidance on how employers calculate the insurance premium-based tax credit.While regulations have not been released, the new IRS guidance offers significant flexibility for employers in calculating the tax credit—making it critical for employers to keep detailed records and abide by the new guidance pending release of final regulations.
IRC Section 45S: Background
Under IRC Section 45S, employers who offer paid family and medical leave are eligible for a tax credit equal to between 12.5% and 25% of qualifying costs if they offer at least two weeks paid time off for qualifying reasons and cover at least 50% of employee wages.The paid leave must be offered pursuant to a written policy to qualifying employees.
Qualifying employees are those who (1) have been employed by the employer at least six months, (2) typically work at least 20 hours per week and (3) had compensation that did not exceed 60% of the compensation threshold for highly compensated employees in the prior year.
The credit is equal to 12.5% of the wages that are paid to qualifying employees during a period where the employee was on family and medical leave if the employee is paid 50% of their normal wages during that time off. The credit increases by 0.25 percentage points (up to a maximum of 25%) for each percentage point by which the payment exceeds 50% of wages.
The OBBBA Premium Calculation Method for IRC Section 45S
Prior to the OBBBA, employers calculated the Section 45S credit based on wages paid to employees on leave (the "wage method").The OBBBA created a new method that allows employers to calculate the credit based on premiums paid for insurance coverage to fund their paid leave obligations (the "premium method).
Pursuant to IRS Notice 2026-28, employers can claim the credit using the premium method even if no employee has taken qualifying leave during the year. Premiums only qualify for the tax credit, however, if they fund a benefit that would have qualified under the wage method if the employee had actually taken leave (the IRS refers to this as "creditable coverage").
Some insurance policies cover both qualifying benefits and non-qualifying benefits.The IRS takes a look-through approach in these cases.When insurance policies provide both creditable and non-creditable coverage, the employer must allocate the premium between the creditable and non-creditable portion of the "blended premium", using any reasonable method.That method must be applied consistently, be supported by contemporaneous records and use objective criteria.
For example, amounts are not qualifying (non-creditable) if the premium funds leave that does not qualify as family or medical leave under Section 45S.Similarly, if the premium funds leave for a person who was not a qualifying employee at the time the premium was paid, it is non-creditable.
The IRS was also clear that employers may now use both the wage and premium method during the same tax year (for example, if a portion of the benefit is covered by insurance and a portion is paid out of the employer's general assets).Of course, no "double dipping" is permitted.Employers cannot claim the wage-based credit for the portion of the benefit funded by insurance if they used the premium method for that portion.
Impact of State and Local Paid Leave Laws
A patchwork of state and local laws may now require employers to offer paid time off for reasons that would also qualify the employer for the Section 45S federal tax credit.Leave mandated by state or local law can be counted in determining whether the employer has offered enough leave to qualify for the credit beginning with the 2026 tax year.
However, wages or insurance premiums that are paid because of a legal requirement are excluded when the employer calculates the federal credit.Premiums paid for by a state or local government are also excluded.
Conclusion
Taxpayers are permitted to rely on Notice 2026-28 today and for tax years beginning after December 31, 2025—until proposed regulations are released.The premium-based method can make the credit significantly more attractive to employers, meaning that employers who have yet to develop a paid leave policy may have new interest in the employee benefit option.