FMLA-Based Employer Credit Under the TCJA Addressed in IRS Guidance

Practical Law Legal Update w-016-7532 (Approx. 9 pages)

FMLA-Based Employer Credit Under the TCJA Addressed in IRS Guidance

by Practical Law Employee Benefits & Executive Compensation

Employers That Are Eligible for the Credit

Under the Notice, employers need not be subject to Title I of the Family Medical Leave Act (FMLA) to be eligible for the Section 45S employer credit. Rather, any employer is eligible for the credit if it:

Has a written policy in place that provides paid family and medical leave (as described in the Notice).
Satisfies the minimum paid leave requirements (as also addressed in the Notice; see Minimum Paid Leave Policy Requirements).
Includes specified "non-interference" language, if applicable.

The Notice addresses content requirements that must be reflected in an eligible employer's written policy providing paid family and medical leave. For example, an employer's written policy must provide all qualifying employees with at least two weeks of paid family and medical leave (prorated for part-time employees), at a rate of at least 50% of the employee's normal wages. If an employer employs any "qualifying employees" who are not covered by FMLA Title I, its policy must include certain "non-interference" language (see Employer Credit for Paid Family and Medical Leave Under 2017 Tax Reform (Code Section 45S): Qualifying Employees).

Documenting Section 45S Policies

An employer's Section 45S policy may be reflected in either a single, stand-alone document or multiple documents. For example, an employer may maintain different documents to cover different classifications of employees or different types of leave, which could collectively comprise the employer's Section 45S policy.

A written policy could also be included in a document that governs the employer's other leave policies. However, if an employer's policy provides paid leave for FMLA purposes and additional paid leave for other reasons (for example, vacation or personal leave), only the leave that is specifically designated for FMLA purposes is family and medical leave under Section 45S.

When Employer's Written Policy Must Be in Place; Transition Rule

As a general rule (and subject to a transition rule), an employer's Section 45S policy must be in place before the paid family and medical leave for which the employer claims the credit is taken. The policy is considered to be in place on the later of the policy's adoption date or effective date.

Under a special transition rule applicable for an employer's first taxable year beginning after December 31, 2017, a written leave policy or amendment to a policy (whether a new policy for the tax year or an existing policy) is considered to be in place as of the policy's or amendment's effective date, rather than a later adoption date, if two requirements are met. First, the policy or amendment must be adopted on or before December 31, 2018. Second, the employer's leave practices must be operated consistent with the retroactive policy's or amendment's terms for the entire period covered by the policy or amendment, including making any retroactive leave payments by the last day of the tax year.

Notice of Employer's Written Policy Generally Not Required

An employer need not provide notice to employees that it has adopted a written policy that provides for Section 45S paid family and medical leave. However, if an employer chooses to provide notice of its policy, the availability of paid leave must be communicated to employees in a manner reasonably designed to reach each qualifying employee. Otherwise, the policy will not be considered to provide for paid leave to all qualifying employees (as required under Section 45S). Acceptable methods for furnishing this notice may include:

Email communication.
Use of internal websites.
Employee handbooks.
Posted displays in employee work areas.

Types of Family and Medical Leave for Which the Credit Can Be Claimed

An eligible employer may claim the Section 45S credit only with regard to paid family and medical leave as defined under the FMLA (29 U.S.C. Section 2612(a)(1) or (3)), whether the leave is provided under the FMLA or by an employer's policy. If an employer provides paid leave as vacation, personal, or medical/sick leave (other than leave specifically for one or more of the FMLA purposes), that paid leave is not considered family and medical leave under Section 45S.

The "FMLA purposes" for which paid family and medical leave under Section 45S may be provided are:

Birth of an employee's son or daughter (and to care for the son or daughter).
Placement of a son or daughter with the employee for adoption or foster care.
Caring for an employee's spouse, son, daughter, or parent who has a serious health condition.
A serious health condition that makes the employee unable to perform the functions of the employee's position.
Any "qualifying exigency" (as determined by regulation) arising from the fact that an employee's spouse, son, daughter, or parent is a member of the Armed Forces (including the National Guard and Reserves) who either:
- is on covered active duty; or
- has been informed of an impending call or order to covered active duty.
Caring for a covered service member with a serious injury or illness if the employee is the service member's spouse, son, daughter, parent, or next of kin.

Subject to a limited exception, paid leave made available to an employee is considered family and medical leave for Section 45S purposes only if the leave:

Is specifically designated for one or more FMLA purposes.
May not be used for any other reason.
Is not paid by a state or local government or required by state or local law.

A limited exception applies if an employer's policy provides paid leave that otherwise would be specifically designated for an FMLA purpose, except that the leave is available to care for individuals in addition to those specified in the FMLA (for example, a grandchild or grandparent with a serious medical condition). Under this exception, the fact that the leave could also be used to care for additional individuals for whom care under the FMLA is not required does not prevent the leave from being considered designated for an FMLA purpose. However, the employer may not claim the Section 45S credit for any leave taken to care for an individual other than a qualifying employee's spouse, parent, or child.

Paid Leave Under Short-Term Disability Policies

Paid leave provided under an employer's short-term disability (STD) program may be characterized as family and medical leave under Section 45S:

Whether it is self-insured by the employer or provided through an insured STD policy.
If the STD program otherwise meets the requirements to be family and medical leave under Section 45S.

Minimum Paid Leave Policy Requirements

An employer is not eligible for the Section 45S credit unless the employer's policy meets the following minimum requirements concerning the paid family and medical leave:

The policy provides at least:
- two weeks of annual paid family and medical leave to all non-part-time qualifying employees; and
- a proportionate amount of paid family and medical leave to part-time qualifying employees.
The policy requires a rate of payment that is not less than 50% of the wages normally paid to the qualifying employee for services performed for the employer.

In addition, if the employer employs one or more qualifying employees who are not covered by FMLA Title I, the policy must include certain "non-interference" language.

Meaning of Part-Time Employees

For Section 45S purposes, a part-time employee is an employee who is typically employed for fewer than 30 hours per week. Until further guidance is issued, employers may use any reasonable method to determine how many hours an employee customarily works per week for the employer. This includes the methods provided in 29 C.F.R. Section 2530.200b-2 for calculating hours of service in connection with certain benefits-related requirements, for example, the Affordable Care Act's (ACA's) employer mandate (see Practice Note, Employer Mandate Under the ACA: Determining Full-Time Employees for Employer Penalties: Calculating Hours of Service).

Paid Leave Ratio Keyed to Expected Weekly Hours Worked (Part-Time/Full-Time)

Regarding part-time employees, the paid leave ratio must be at least equal to the ratio of:

The expected weekly hours worked by a qualifying employee who is a part-time employee.
The expected weekly hours worked by an equivalent non-part-time qualifying employee (under Code Section 45S(c)(1)(A)(ii)).

In determining the amount of paid family and medical leave provided by the employer for purposes of Section 45S purposes, any leave paid by a state or local government or required by state or local law is not taken into account.

Determining Who Are Qualifying Employees

Several of the Notice's Q&As address the meaning of qualifying employees for Section 45S purposes (see Practice Note, Employer Credit for Paid Family and Medical Leave Under 2017 Tax Reform (Code Section 45S): Qualifying Employees). For example, among other requirements, a qualifying employee is one who has been employed by the employer for one year or more. The Notice clarifies that (subject to future guidance) an employer may use any reasonable method to determine whether an employee has been employed for one year or more. For example, an employer could treat employees as employed for one year or more if they have been employed for 12 months (29 C.F.R. § 825.110(b)). However, it would not be a reasonable method for an employer to require an employee to work 12 consecutive months to be considered a qualifying employee.

In addition, until further guidance is issued, any requirement that an employee must work a minimum number of hours to be a qualifying employee would not be viewed as a reasonable method for determining whether an employee has been employed for one year. FMLA rules under which an employee must work a minimum of 1,250 hours of service to be an eligible employee under the FMLA do not apply in the Section 45S context.

An Employer's Policy May Not Exclude Classifications of Employees

An employer's Section 45S policy may not exclude any classification of employees (for example, collectively bargained employees) if they are qualifying employees. An example in the Notice applies this rule in the context of an employer's STD policy that effectively excludes employees with a disability resulting from a preexisting condition when they first become qualifying employees under the policy.

Employees Who Later Become Qualifying Employees

An employer may not claim the Section 45S credit for an employee who:

Was not a qualifying employee when the paid family and medical leave was taken.
Becomes a qualifying employee later in the tax year.

An employer may claim the credit only as to wages paid to an employee who is a qualifying employee at the time family and medical leave is taken. Wages paid to an employee for family and medical leave taken before the employee becomes a qualifying employee are excluded in determining the employer's credit. However, an exception exists for an employer's policy that:

Permits employees to take paid family and medical leave before they become qualifying employees.
Does not provide a dedicated amount of leave that satisfies the minimum paid leave requirements that may only be taken after an employee becomes a qualifying employee.

In this case, the leave does not fail to:

Be specifically designated for an FMLA purpose.
Meet the minimum paid leave requirements, solely because an employee may take paid leave before becoming a qualifying employee.

Determining Wages That Are Normally Paid to an Employee

An employer's Section 45S policy must provide that each qualifying employee who is on paid family and medical leave will be paid at least 50% of the wages normally paid to the employee for services performed for the employer.

Under the Notice, wages normally paid to an employee means the wages normally paid to the employee for services performed for the employer. This definition excludes overtime (other than regularly scheduled overtime) and discretionary bonuses. Subject to future guidance, for employees who are paid (in whole or in part) on a basis other than a salaried or hourly rate, an employer must calculate wages normally paid using the rules for determining regular rates of pay under regulations implementing the Fair Labor Standards Act (FLSA) (29 C.F.R. § 778.109).

The Notice also addresses how an employer determines the normal hourly wage rate for an employee who is not paid an hourly wage rate (26 U.S.C. § 45S(b)(1). Until further guidance is issued, an employer may use any reasonable method to convert normal wages paid to an employee who is not paid an hourly wage rate to an hourly rate.

No Uniformity Requirement

Under the Notice, an employer's rate of payment (or period of paid family and medical leave) need not be uniform for all qualifying employees and all FMLA purposes. However, if an employer's policy provides different rates of payment (or periods of paid family and medical leave) for different FMLA purposes, the minimum paid leave requirements must be satisfied regarding each FMLA purpose for which the employer intends to claim the credit.

In addition, if an employer's policy provides a uniform rate of payment (and period of paid family and medical leave) for all qualifying employees and for all FMLA purposes (or a uniform rate of payment and period for several specified FMLA purposes):

The policy as a whole must satisfy the minimum paid leave requirements.
The minimum paid leave requirements need not be satisfied separately for each FMLA purpose.

The Notice includes several examples illustrating these rules.

Leave Paid or Required By a State or Local Government

Leave paid by a state or local government (or required by state or local law) is not considered in determining whether an employer's Section 45S policy provides a rate of payment of at least 50% of the wages normally paid to an employee for services performed for the employer. To be eligible to claim the credit, an employer must independently satisfy the minimum paid leave requirements – including providing a rate of payment of at least 50% of wages normally paid to an employee.

Calculating and Claiming the Credit

An eligible employer's Section 45S credit equals the "applicable percentage" of wages paid to the employer's qualifying employees during any period (up to 12 weeks) in which the employees are on family and medical leave (26 U.S.C. § 45S(a)(1); see Practice Note, Employer Credit for Paid Family and Medical Leave Under 2017 Tax Reform (Code Section 45S): Calculating the Section 45S Credit). "Applicable percentage" means 12.5% increased (but not above 25%) by 0.25 percentage points for each percentage point by which the rate of payment exceeds 50% (26 U.S.C. § 45S(a)(2)).

The meaning of wages under the Federal Unemployment Tax Act (FUTA) (26 U.S.C. Section 3306(b)), determined without regard to the $7,000 FUTA wage limit, is used for Section 45S purposes. Code Section 3306(b) generally defines wages as all remuneration for employment, subject to certain limits. Wages for Section 45S purposes do not include amounts taken into account in determining any other credit allowed under Code Section 38 (26 U.S.C. § 38), which contains several separate business-related credits (for example, the ACA's small employer health insurance business credit) (26 U.S.C. § 45R; see Practice Note, Small Business Health Care Credit Under the ACA).

Wages paid by a third-party payer (for example, an insurer, professional employer organization (PEO), or a Certified PEO) to qualifying employees for services performed for an employer are considered wages for Section 45S purposes (see Standard Document, PEO Client Service Agreement). However, only the employer, and not the third-party payer, may take into account wages paid to qualifying employees for services performed for the employer in determining the credit under Section 45S.

How an Employer Claims the Credit

An employer claims the Section 45S credit by filing the following forms with its tax return:

IRS Form 8994 (Employer Credit for Paid Family and Medical Leave).
IRS Form 3800 (General Business Credit).

How Section 45S Affects an Employer's Deduction for Wages or Salaries Paid

The Notice addresses how claiming a Section 45S credit affects an employer's deduction for wages or salaries paid for the tax year. Specifically, Code Section 280C denies a deduction for wages or salaries paid for the tax year equal to the amount of the credit. Under Section 280C, an employer's deduction for wages paid is reduced by an amount equal to the amount of the credit (26 U.S.C. § 280C(a)).

Other Administrative Issues

Employers are not aggregated for purposes of calculating the Section 45S employer credit. The Notice indicates that employers are only aggregated for one purpose under Section 45S. Specifically, Section 45S provides that all persons who are treated as a single employer (under Code Sections 52(a) and (b)) are treated as a single taxpayer (26 U.S.C. § 45S(c)(3)). As a result, employers are aggregated for purposes of a Section 45S rule under which employers may elect to have Section 45S not apply for any taxable year. (For more information, see Practice Note, Controlled Group and Affiliated Service Group Rules.)

Practical Impact

The Notice's Q&As are the most extensive implementing guidance we've received to date regarding the TCJA's Section 45S employer credit, and cover a good deal of ground as to complying with the credit's statutory requirements. Ultimately, according to the IRS, the Q&As will be incorporated into proposed regulations addressing Section 45S. Comments concerning the Notice's Q&As are due November 23, 2018, meaning that the IRS's proposed regulations will not be issued – in all likelihood – until early 2019.

FMLA-Based Employer Credit Under the TCJA Addressed in IRS Guidance | Practical Law