New IRS guidance on tax treatment of state paid leave programs

Posted January 23, 2025

Executive summary:

Several states, including California, Colorado, Connecticut, Delaware, the District of Columbia, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, and Washington require, or will soon require, employers and employees of in-state companies to pay into a State Paid Family and Medical Leave (State PFML) program that provides medical leave and family leave wage replacement to eligible employees.
Prior IRS guidance on the taxation of contributions into State PFML programs and taxation of the benefits paid out from these State PFML programs has been unclear.
The IRS has issued new Rev. Rul. 2025-4 clarifying the taxation and reporting of contributions to these programs and benefits paid to eligible employees from these programs.

State PFML programs vary from state to state, but generally provide wage replacement for employees that cannot work due to their own non-occupational injuries, illnesses, or medical conditions, or to care for a family member due to the family member’s serious health condition or other prescribed circumstance. Under most State PFML programs, both the employer and the employee are required to contribute into the state program. Generally, the state requires the employer to withhold amounts from employee wages and deposit the withheld employee portion, along with an employer portion, with the state program. A few programs allow an employer to “pick-up” the employee’s portion of the payment into the state program that otherwise would be deducted from wages (voluntary employer pick-up contributions). The proper tax treatment of both the contributions and benefits paid under these programs has been uncertain.

Rev. Rul. 2025-04 provides clarification on the tax treatment and reporting for both the contributions into the State PFML programs and the benefits paid from the State PFML programs. Using a generic example of a State PFML program, the revenue ruling. describes five alternative situations and concludes on the tax treatment of contributions, benefits, and appropriate reporting.

Income Tax and Reporting of Contributions into the State PFML Program

Under the revenue ruling, there are three possible types of contributions into a state program with respect to a given employee:

Required employer contributions: Not taxable to employees. No reporting.
Required employee contributions (generally withheld via payroll): Taxable income and wages reported on Form W-2, Wage and Tax Statement.
Voluntary employer pick-up contributions (as permitted): Taxable income and wages reported on Form W-2.

Tax Deductions for contributions to State PFML Programs

Employer: Contributions, whether mandatory or voluntary employer pick-up contributions, are deductible as business expenses (either as wages or as excise taxes).
Employees: Contributions included in the employee’s taxable income (as discussed above) may be tax deductible on an employee’s own federal income tax return as state and local income taxes (up to limitations) if the employee itemizes deductions. Note, however, that many employees do not itemize state taxes because the standard deduction is more beneficial.

Income Tax Treatment & Reporting of Benefits Paid under State PFML Programs

The federal income tax treatment and reporting of benefits paid out of State PFML programs to employees differs based on whether amounts are attributable to employer contributions (including voluntary employer pick-up contributions) or employee contributions and whether the employee is receiving benefit payments for family leave or medical leave under the State PFML program.

Because of these differences, the State PFML programs will likely need to keep track of the types of contributions that have been made by employees and employers.

In general, the tax treatment is as follows:

Family Leave Benefit Payments
Amounts attributable to required employer contributions, required employee contributions, and voluntary employer pick-up contributions: Taxable income to the employee but not treated as wages (and thus not subject to withholding and not reportable on a Form W-2). The state will report such amounts to an employee on a Form 1099.

Medical Leave Benefit Payments
Amounts attributable to mandatory employer contributions: Generally treated as taxable income and wages unless amounts can be excluded under sections 104 and 105 (relating to amounts treated as received through accident or health insurance).
For reporting, the taxable medical leave benefit is treated as third-party sick pay paid by a party that is “not an agent of the employer.” Under this rule, while federal income tax withholding is not required, an employee can request federal income tax withholding on these taxable amounts. Social Security and Medicare tax withholding may also be required, and the amounts are usually reported on Form W-2.
Amounts attributable to mandatory employee contributions and voluntary employer pick-up contributions: The medical leave benefit paid by the State PFML program that is attributable to mandatory employee contributions and any voluntary employer pick-up contributions (both of which should have been included in employee wages at the time of the contribution) are not taxable to the employee.

Transition Period

The revenue ruling is generally effective for contributions or payments made on or after Jan. 1, 2025. However, the revenue ruling provides that the 2025 calendar year is a transition year for both employers and states, giving them time to configure their reporting and other systems and facilitate an orderly transition. For medical leave benefit payments attributable to employer contributions made during 2025:

The state or employer is not required to follow the withholding and reporting requirements applicable to third-party sick pay.
The state or employer will not be subject to penalties for failure to correctly file information returns or employee payee statements.
The state or employer is not required to withhold and pay associated taxes and is not liable for associated penalties.

Additionally, the employer is not required to treat voluntary employer pick-up contributions as wages for federal employment tax purposes.

Next Steps

Companies with employees in states with these programs should carefully review the guidance and prior reporting of these items. Depending on what employers and various State PFML programs have been doing in the past, this guidance may require additional reporting by both employers and the State. The IRS is asking for comments on the guidance by April 15, 2025.

This article was written by Karen Field , Jill Harris and originally appeared on 2025-01-23. Reprinted with permission from RSM US LLP.
© 2024 RSM US LLP. All rights reserved. https://rsmus.com/insights/tax-alerts/2025/new-irs-guidance-on-tax-treatment-of-state-paid-leave-programs.html

RSM US LLP is a limited liability partnership and the U.S. member firm of RSM International, a global network of independent assurance, tax and consulting firms. The member firms of RSM International collaborate to provide services to global clients, but are separate and distinct legal entities that cannot obligate each other. Each member firm is responsible only for its own acts and omissions, and not those of any other party. Visit rsmus.com/about for more information regarding RSM US LLP and RSM International.

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.