There continues to be a lot of discussion about the Tax Cuts and Jobs Act, signed into law in December 2017. There are new tax rates for individuals and corporations and different ways to apply existing provisions of the tax code. One new credit, however, has been largely ignored and may provide a significant tax benefit for businesses that are paying employees under the Family Medical Leave Act of 1993 (FMLA).
This article will explain how to calculate and claim the credit, but there are many nuances and exceptions, so it’s important that you consult with a CPA.
Overview
An employer may be eligible for a credit equal to a maximum of 25% of the normal wages paid to a qualifying employee under a written policy that satisfies certain requirements. The credit is generally effective for wages paid in tax years beginning after December 31, 2017, but is not effective for wages paid in years beginning after December 31, 2019.
It is important to understand how a business calculates the credit. Key definitions that we’ll discuss include:
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Written policy
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Qualifying employee
Written Policy
Many employers are already subject to FMLA, which requires that certain employers provide employees up to 12 weeks of leave, at the end of which employees may return to the same position and still retain group health benefits. FMLA does not require that an employer pay an employee during this period of time.
The first requirement an employer must satisfy to claim the credit is to have a proper written policy of compensation under FMLA. An employer satisfies this requirement by having a written policy wherein the employer provides at least two weeks (prorated for part-time employees) annually of paid family and medical leave at a rate of at least 50% of the wages normally paid to them.
If an employer doesn’t have a policy in place, they may adopt one by December 31, 2018 and consider it to be retroactive to January 1, 2018 as long as the employer brings its leave practices into compliance with the terms of the retroactive policy for the entire year.
Qualifying Employee
A qualifying employee for the purposes of this credit calculation is anyone who has worked for the employer for one year or more and is not considered a highly compensated employee. For 2018 and for the purposes of this credit, the IRS considers an employee to be highly compensated if they earn in excess of $72,000. While the “one year or more” definition is also undefined, the IRS has indicated that:
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Employers may use any reasonable method to determine whether an employee has been employed for one year or more
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An employer requiring that an employee work 12 consecutive months is NOT a reasonable method to determine a qualifying employee
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There is no minimum number of hours per year that automatically qualifies or disqualifies an employee from being qualified for the purposes of this credit calculation
Family and medical leave may be taken for several reasons as described under FMLA, the most common of which are for the birth and care of a newborn child of the employee, and the care for an employee’s spouse, child, or parent who has a serious health condition.
Credit Calculation
A business will calculate the credit in two steps as follows:
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12.5% of an employee’s pay on family and medical leave plus
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0.25% for each percentage point by which the wages paid for family and medical leave exceed 50% of the employee’s normal wages
So, as an example, if an employee would regularly earn $10,000 and the employer pays this employee $6,500 while the employee takes family and medical leave, the calculation of the $1,625 credit would be as follows:
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$1,250 (since the employee is paid more than 50% of their normal wages, 12.5% x $10,000) plus
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$375 (the employee is paid 65% of their normal wages, which is 15 percentage points more than 50% of the employee’s normal wages [15 BP x 0.25% = 3.75% x $10,000 = $375])
The maximum credit is 25% of the employee’s normal wages, which would be taken if the employer pays the employee 100% of their normal wages while on family and medical leave.
The IRS has not formally provided a definition of “normal wages,” but has said that discretionary bonuses and overtime are excluded. Generally, an employer would use the employee’s annual salary or hourly rate. If this is not applicable, employers should use the Fair Labor Standards Act of 1938 to determine an employee’s regular pay rate. The employer must also reduce its deduction for compensation on its tax return by the amount of the credit.
Need Help?
This credit may provide unexpected relief for employers with employees who are paid under FMLA. The IRS FAQ page offers more information on this tax credit. Contact us online or call 800.899.4623 for help.
