Paid Family and Medical Leave Tax Credit: The Permanent Section 45S Rules for 2026

The paid family and medical leave tax credit under Section 45S gives employers a general business credit of 12.5% to 25% of the wages they pay qualifying employees during up to 12 weeks of family or medical leave each year. The One Big Beautiful Bill Act made it permanent for tax years beginning after December 31, 2025, and added an option to base the credit on insurance premiums instead of leave wages.

To qualify, an employer needs a written policy that gives qualifying employees at least two weeks of paid family and medical leave a year at 50% or more of normal wages. This guide covers how the paid family and medical leave tax credit works in 2026, the new premium method, the change for state-mandated leave, the employee tests, and how to claim it on Form 8994, with a worked example.

What Changed for the Paid Family and Medical Leave Tax Credit in 2026

Section 45S first appeared in the 2017 tax law as a temporary provision and was extended twice before Section 70304 of Pub. L. 119-21 (the One Big Beautiful Bill Act, which the IRS now calls the Working Families Tax Cuts) removed the termination date. The amended statute at Cornell LII shows the changes, and the effective date note says they apply to taxable years beginning after December 31, 2025.

The main changes for 2026 are these:

• Permanence. The old Section 45S(i), which ended the credit for wages paid in tax years beginning after 2025, was struck.
• Premium method. An employer that has an insurance policy for paid family and medical leave in force during the year can elect to claim the credit on premiums paid or incurred for that policy.
• State and local leave. Leave required by state or local law now counts toward the policy minimums, although it still generates no credit.
• Six-month election. Employers can elect to treat employees as qualifying after 6 months of service instead of 1 year.
• 20-hour floor. Qualifying employees must be customarily employed for at least 20 hours per week.
• Aggregation. All persons treated as a single employer under Section 414(b) and (c) are treated as one employer, so related companies generally need a qualifying policy across the group.

The IRS summarized the expansion in IR-2026-86, released August 5, 2026, along with Notice 2026-28 on the premium method.

How the Credit Rate Works: 12.5% to 25%

The credit rate is called the applicable percentage. It starts at 12.5% when the policy pays exactly 50% of normal wages and rises by 0.25 percentage points for each percentage point above 50%, up to a cap of 25% at full pay. The table shows common replacement rates.

Two limits apply under the wage method. Leave counted for any one employee is capped at 12 weeks per taxable year, and the wages taken into account cannot exceed the employee's normal hourly wage rate multiplied by the hours of leave taken. For salaried staff, wages are prorated to an hourly rate.

"Wages" for this credit means wages under the FUTA definition in Section 3306(b), without the $7,000 FUTA wage base, so the same payroll data behind your quarterly Form 941 is the starting point. Wages already used for another general business credit cannot be counted again, which matters for employers that also claim the research credit on staff wages or the FICA tip credit on Form 8846.

The Written Policy Requirement

An employer is an "eligible employer" only if it has a written policy in place that meets two minimums. Full-time qualifying employees must receive at least 2 weeks of annual paid family and medical leave, and part-time qualifying employees must receive a proportionate amount based on their expected weekly hours. The policy must also pay at least 50% of the wages normally paid to the employee.

The Form 8994 instructions add practical rules that still apply:

• The policy must be in place before the leave for which you claim the credit is taken. It is treated as in place on the later of its adoption date or its effective date.
• The policy may not exclude any classification of qualifying employees, such as collectively bargained staff.
• Notice to employees is not required to claim the credit. If you do give notice, it must be communicated in a way reasonably designed to reach each qualifying employee.

Employers with qualifying employees who are not covered by Title I of the FMLA must also include non-interference and non-retaliation language in the policy. Only leave for FMLA purposes counts. General vacation, personal or sick leave does not, unless it is specifically designated for one of those purposes. Many employers fold the policy into the same handbook section that describes their Section 125 cafeteria plan and other benefits, which keeps eligibility language consistent.

The Employment Test: Who Is a Qualifying Employee

Under amended Section 45S(d), a qualifying employee is an FLSA employee who meets all three of these tests:

1. Employed by the employer for 1 year or more, or for at least 6 months if the employer elects the shorter period.
2. Prior-year compensation, annualized and prorated for part-time staff, of no more than 60% of the Section 414(q)(1)(B)(i) highly compensated employee amount for that year.
3. Customarily employed for at least 20 hours per week.

For 2026 claims, the compensation test looks at 2025 pay. The compensation limit table in the Form 8994 instructions lists a 2026 limit of $96,000, which is 60% of the $160,000 Section 414(q) amount for 2025. The limit for 2025 claims was $93,000. An employee who earned more than $96,000 in 2025 is not a qualifying employee for 2026 leave. Fiscal-year employers can use either their preceding fiscal year or the calendar year ending in it.

The six-month election is the change most likely to widen the pool for businesses with seasonal or high-turnover staff. Track hire dates carefully, since a premium or leave payment for someone who has not yet met the service test produces no credit.

The New Insurance Premium Option

Starting in 2026, an employer can elect to compute the credit on premiums for a paid family and medical leave insurance policy instead of on leave wages. The rate of payment under the policy sets the applicable percentage, and the statute says that rate is determined without regard to whether any qualifying employee actually took leave during the year. That means a premium can produce a credit in a year with no leave claims.

Notice 2026-28 explains how the premium method works until proposed regulations are issued. Its main points:

• A premium is creditable only to the extent it funds a benefit that would earn a credit under the wage method if paid as wages.
• Premium portions for leave that is not family and medical leave under Section 45S(e), for individuals who are not qualifying employees when the premium is paid, or for leave required by state or local law or paid for by a state or local government, are not creditable.
• A blended premium covering both creditable and noncreditable coverage must be allocated using a reasonable method with objective criteria, consistent with the policy terms, supported by contemporaneous records and applied consistently across the aggregated group.
• An employer can use the wage method for some leave and the premium method for other leave, but cannot claim both for the same instance of leave.

The notice says taxpayers may rely on it for taxable years beginning after December 31, 2025, and before proposed regulations are issued. Treasury asked for comments by October 16, 2026, including on voluntary state-facilitated programs run by private insurers, so expect further guidance.

Section 280C(a) also changed. Under the wage method you reduce your wage deduction by the credit, and under the premium method no deduction is allowed for the portion of premiums equal to the credit. This interacts with how leave benefits are taxed to employees, which our guide to fringe benefits and taxes covers in more detail.

How State-Mandated Leave Is Treated Now

Before 2026, leave paid by a state or local government or required by state or local law did not count when testing whether an employer met the policy minimums, so an employer had to meet the two-week and 50% tests on its own. Under the amended Section 45S(c)(4), that leave now counts when you test whether your policy provides the required minimum leave, but it still does not count when you compute the credit.

In practice, an employer in a state with a paid leave mandate can count the mandated benefit toward the policy minimums, and then claim the credit only on leave it provides above the state requirement. Notice 2026-28 applies the same rule to premiums: the part of a premium that funds state-required leave is not creditable. As of October 2026, the treatment of voluntary plans that some states let employers buy from private insurers is still an open comment item.

Worked Example: Wage Method and Premium Method

These figures are illustrative and assume a calendar-year employer whose policy meets every requirement above, in a state with no paid leave mandate.

Wage method. Priya earns $25 an hour and normally works 40 hours a week. She earned $52,000 in 2025, below the $96,000 limit, and has 2 years of service. The employer's written policy pays 75% of normal wages for up to 8 weeks of family and medical leave, and Priya takes 6 weeks in 2026.

The employer's wage deduction falls by $843.75, so the credit reduces the cost of the leave from $4,500 to $3,656.25 before the deduction effect.

Premium method. The same employer instead buys an insured paid leave policy that replaces 60% of wages for up to 12 weeks, for a $18,000 annual premium covering 40 employees. Ten of them are not qualifying employees (some earned over $96,000 in 2025 and some have under 6 months of service even with the election), so the employer allocates the premium by covered headcount, documented from its payroll records.

The $2,025 credit is available whether or not anyone takes leave in 2026. A headcount split is one possible reasonable method. Your allocation should reflect the actual policy terms and be applied the same way across every entity in the controlled group.

How to Claim the Credit on Form 8994

The credit is figured on Form 8994 and flows to Form 3800 as part of the general business credit, so the usual limits, carrybacks and carryforwards apply. Our guide to claiming the general business credit on Form 3800 explains those rules.

Partnerships and S corporations must file Form 8994 to claim the credit. Partners and shareholders whose only source of the credit is a pass-through entity report it directly on Form 3800 instead. You can claim the credit, or elect not to claim it, within 3 years of the return's due date on an original or amended return.

As of October 2026, the IRS still lists the January 2021 revision of Form 8994 and the December 2024 instructions, both of which predate the premium method and the six-month election. Check IRS.gov/Form8994 for a newer revision before filing a 2026 return.

Good records make the claim straightforward. Keep the dated written policy, employee hire dates and prior-year compensation, leave hours and pay by employee, and premium invoices with your allocation workpapers. Adding these items to your payroll compliance checklist means the support is ready when the return is prepared.

Frequently Asked Questions

Is the paid family and medical leave tax credit permanent? Yes. The One Big Beautiful Bill Act struck the termination date in Section 45S, so the credit continues for taxable years beginning after December 31, 2025, with no scheduled end date.

What is the maximum credit percentage? The credit is 25% of qualifying leave wages or creditable premiums when the policy pays 100% of normal wages. At the 50% minimum, the rate is 12.5%, and it rises 0.25 points for each point of wage replacement in between.

Can I claim the credit if no employee took leave this year? Yes, under the premium method. If you have a qualifying paid leave insurance policy in force, the credit is based on creditable premiums paid or incurred, and the statute determines the rate of payment without regard to whether anyone took leave.

Does state paid family leave count toward the federal credit? State-required or state-paid leave counts toward the policy minimums from 2026. It does not generate any credit, and premiums for state-required coverage are not creditable.

Who can be a qualifying employee in 2026? An employee with at least 1 year of service, or 6 months if you elect it, who is customarily employed at least 20 hours a week and earned no more than $96,000 in 2025.

Next Step

Madras Accountancy supports US CPA firms and businesses with payroll, bookkeeping and tax preparation work, including gathering the payroll and policy records behind business credits such as Section 45S. To talk through your paid leave credit workpapers or broader payroll outsourcing needs, contact our team.