The patchwork of U.S. paid leave programs makes coordination and administration difficult, particularly for multistate and small employers. As a result, some employers have begun buying insurance products for wage replacement benefits during paid leave. Cost is another challenge, although recent legislation provides some relief through a tax credit for employers that offer paid family and medical leave (PFML) under Internal Revenue Code (IRC) Section 45S. The credit offsets a portion of the employer’s PFML costs, such as for insurance premiums to provide leave (for example, short-term disability) or for the wages paid during leave.

Nine states adopted voluntary paid family leave systems by allowing the provision of the benefit in the private insurance market, and seven states permit insurance companies to sell paid family leave insurance, according to the Bipartisan Policy Center (as of October 2026).

Paid Leave Tax Credit Laws

In 2017, the Tax Cuts and Jobs Act became law, amending the IRC by including a two-year trial of a new tax credit for employers offering PFML to employees. The trial was extended several times through 2025 when the One Big Beautiful Bill Act (OBBBA) made the provision permanent for tax years beginning after December 31, 2025 and expanded the eligibility for employers to claim the credit. According to an IRS news release, employers now have greater incentives to offer up to 12 weeks of paid leave and can claim the credit for employees with six months of service or for part-time employees working 20 hours or more per week.

On August 5, 2026, the Internal Revenue Service (IRS) released Notice 2026-28, which includes a series of questions and answers (Q&As) on the credit and its expanded provisions. There is a new method for employers to claim the credit based on insurance premium amounts paid.

Types of Paid Leave

According to the Department of Labor, paid leave generally covers:

• PFML
• Sick time
• Other paid time off include vacations, emergencies, personal days, and other specific purposes.

Qualifying Reasons for Paid Leave Under Section 45S

The reasons for PFML generally align with those for Family and Medical Leave Act (FMLA), including:

• Birth and care for a newborn child
• Placement and care of a child through adoption or foster care
• Caring for a spouse, child or parent with a serious health condition
• The employee’s own serious health condition that prevents them from working
• A qualifying need arising from a spouse, child or parent’s covered military duty
• Caring for a covered servicemember with a serious injury or illness.

Written Policy Requirements for Eligible Employers

The expanded credit applies to businesses of any size if they have federal tax liability. Nonprofits and companies operating at a loss are excluded.

To receive the credit, employers are required to have a written PFML policy in place that:

• Provides qualified employees with at least two weeks of PMFL annually for all full-time employees and prorated for part-time employees
• Provides wage replacement of at least 50% during paid leave
• Bars discrimination against or termination of any individual for opposing any practice prohibited by the policy. Q&A 3 of Notice 2018-71 provides sample language for the written policy.

Employee Compensation Limit

Qualifying employees are those employed for at least one year whose prior-year compensation didn’t exceed a set dollar amount. For 2026, that means no more than $96,000 in the preceding year.

Tax Credit Calculation Methods

Notice 2026-28 focuses on the new premium method. Beginning in 2026, businesses calculate the tax credit using one of two methods:

• Wage method: Calculate the credit based on wages paid to eligible employees while they are on leave. This was the only method available before the 2025 changes.
• Premium method: Calculate the credit based on private insurance premiums paid for short-term disability plans or other PFML benefits covered by an insurance policy used to provide benefits to employees.

Flexibility but No Double Dipping

An employer can use both methods to claim the credit, using the wage method for some types of leave and the premium method for other types of leave. However, it can’t claim both credits for the same benefits. Employers have the flexibility to determine whether the combination of methods produce the best results or if they should use either the wage or premium method independently.

Avoiding Double Claims

Question 7 of Notice 2026-28 illustrates how the two methods might interact:

• No double-dipping: An employer that claims the premium credit for creditable coverage can’t also claim the wage credit for benefits paid from that premium, and vice versa.
• Split funding: If a single instance of leave is funded partly by the premium and partly from the employer’s general assets, the employer can split the claim, taking the premium credit for the premium-funded portion and the wage credit for the portion paid from general assets.

Calculating the Tax Credit Using the New Option—Premium Method

Under the premium method, an employer can base the PFML credit on the insurance premiums it pays for a paid leave policy, instead of on wages paid while employees are on leave (the wage method). The basic rule is that a premium only counts to the extent it pays for leave that would have earned the credit under the wage method.

To calculate the credit under the premium method, employers generally follow three steps.

Step 1: Only premiums for creditable coverage count. Premiums that cover the following are excluded:

• Leave required by state or local law
• Leave that isn’t PFML as defined in section 45S(e)
• Employees who aren’t “qualifying employees” when the premium is paid or incurred
• Leave paid for by a state or local government
• Benefits that wouldn’t count as wages under section 45S(g).

Step 2: Split blended premiums. If one policy covers both creditable and non-creditable items (for example, qualifying and non-qualifying leave, or qualifying and non-qualifying employees), split the premium between them. You can use any reasonable method, as long as it:

• Uses objective criteria
• Is consistent with policy terms and is backed by records kept at the time
• Is applied the same way throughout the taxable year and across all related entities treated as a single employer.

Step 3: Apply the credit rate limits. The credit rate is 12.5% to 25% depending on the pay amount provided while an employee is on leave, and the rate goes up 0.25 points for each percentage point above 50%, up to 25% at 100% wage replacement.

Under the premium method, the payment rate is set regardless of whether an employee took leave that year.

Calculation Examples

Wage method

• Employee’s weekly wage is $800
• Employee takes eight weeks of qualifying PFML with the employer paying 100% of normal wages
• $800 x 100% wage replacement percentage x 8 weeks x 25% (credit rate for paying 100% of wages) = $1,600 credit

Premium method

• Employer pays $12,000 in 2026 premiums for a policy that provides 60% wage replacement for PFML
• $12,000 x 60% wage replacement percentage x 25% (credit rate for paying 100% of wages) = $1,800

What’s Next: Proposed Regulations

Employers may rely on the 2026 guidance now as we wait for the formal regulatory process. The Treasury Department and the IRS intend to issue regulations that focus on broader implementation guidance and apply prospectively to wages and insurance premiums paid or incurred after the final regulations are issued.

The International Foundation will be monitoring this topic for further developments.

Developed by International Foundation Information Center staff. This does not constitute legal advice. Please consult your plan professionals for legal advice.