The paid family and medical leave tax credit is now permanent
Posted on:
If you’ve looked at offering paid family or medical leave and walked away because the math didn’t work for your business, it’s worth another look. On August 5, IRS issued Notice 2026-28, laying out how employers can claim the newly permanent paid family and medical leave tax credit under Section 45S.
Here’s what contracting businesses need to know:
The credit is no longer temporary
Section 45S started as a two-year pilot in 2017 and got extended in pieces through 2025, which made it hard to build a leave policy around. It’s now permanent.
Who counts as a qualifying employee
You can now elect to count employees after six months of service instead of a full year. Part-time employees averaging at least 20 hours a week are covered; below 20 hours, they’re out.
The credit only applies to employees who earned no more than 60% of the IRS highly compensated employee limit — $96,000 for 2026 — and it’s based on the prior year’s compensation. Run your roster against the number before you assume the credit covers your whole team.
You can now claim the credit on insurance premiums, not just wages
This is the biggest change and the reason the IRS issued the notice. Starting with tax year 2026, if you carry an insurance policy providing paid family and medical leave coverage, you can elect to base the credit on the premiums you pay rather than on wages paid to employees who actually go out on leave.
Under the premium method, the credit is available whether or not anyone took leave that year. Under the old wage-based approach, you only got a credit if someone had a baby or a serious illness.
If your policy covers leave or employees that wouldn’t qualify under the wage rules, only the qualifying portion of the premium is creditable, and you have to allocate it using a reasonable, documented method. You can use both methods in the same year, just not on the same instance of leave.
How much the credit is worth
The credit amount is 12.5% of qualifying costs if you replace 50% of an employee’s normal wages during leave, rising on a sliding scale to 25% at full wage replacement. This applies to up to 12 weeks per employee per tax year.
You need a written policy
The credit isn’t automatic because you paid someone while they were out. You need a written policy, in place before the leave is taken, that:
- Provides at least two weeks of annual paid family and medical leave to full-time qualifying employees, prorated for part-timers
- Sets wage replacement during that leave at no less than 50%
- Covers at least one FMLA-qualifying reason — parental, family caregiving, medical, or military exigency
- Includes anti-retaliation language protecting employees who raise concerns about how the policy is applied
The leave also has to be specifically designated for family and medical leave. General PTO, vacation, and personal sick days don’t qualify.
If you have fewer than 50 employees
If you have fewer than 50 employees, you aren’t disqualified from the credit, but your policy needs language stating that you won’t interfere with, restrain, or deny an employee’s exercise of rights under it, and won’t discharge or discriminate against anyone for opposing a practice the policy prohibits.
Without that language, the policy doesn’t qualify, and neither does the credit. This is the most common drafting failure for small employers claiming 45S.
If you run more than one entity
If you run a separate service company, install company, or holding entity, the aggregation rules changed. Businesses treated as a single employer under sections 414(b) and (c) are now treated as one employer for this credit, so one entity’s leave policy affects the whole group’s eligibility.
There’s a new exception if you can show a substantial and legitimate business reason why an entity doesn’t maintain a written policy, but the IRS hasn’t defined that yet — it’s an open question in the guidance. If you have more than one EIN, get your CPA on this before you file.
If your state already mandates paid leave
More than a dozen states plus D.C. and a handful of local jurisdictions now run mandatory paid leave programs. Employers in those places used to be shut out of the credit entirely.
Now, mandated leave counts toward showing you provide enough leave to be an eligible employer, and if you top up what the state pays, the difference can count toward the credit. You don’t get credit for what the state already requires, but you do get credit for going above it.
How the credit works on your return
This is a general business credit, so it offsets tax liability. If your business is operating at a loss, there’s nothing to offset in the current year. If you’re an S corp or partnership, the credit passes through to the owners’ returns.
And you can’t deduct the portion of wages or premiums equal to the credit you claim. It’s a credit, not a credit plus a deduction.
What to do before year-end
- Pull your leave policy and read it against the requirements above. If everything lives in one PTO bank, you have work to do.
- Run your roster against the $96,000 prior-year threshold so you know your real credit pool.
- If you’re under 50 employees, confirm your policy has the non-interference language.
- Ask your benefits broker whether a paid family and medical leave insurance product is available in your state and what it costs. Run the premium against a 12.5%–25% credit.
- If you have more than one entity, flag the aggregation issue for your CPA now.
- Decide on the six-month service election.
- Get the written policy signed and dated. 2026 is the first full year the amended rules apply, and the policy has to exist before the leave does.
When you file, the credit is claimed on Form 8994 and carried to Form 3800 with your annual return.
Treasury and the IRS plan to issue proposed regulations later this year and are accepting public comment through October 16, 2026.
