ALERT: The Internal Revenue Service (“IRS”) recently released guidance on how state-paid family and medical leave contributions and benefits should be treated for federal tax purposes.

IRS Revenue Ruling 2025-4, explains the federal income and employment tax treatment of contributions made to, and benefits received from, a state’s paid medical and family leave (“PFML”) program. The Revenue Ruling intends to provide clarity regarding the federal tax treatment for those employees who cannot work because of non-occupational injuries to themselves or family members, as well as sickness and disabilities where the subject state has a mandatory PFML program. These rules are complex and vary depending on several variables. Below is a summary of these rules. If you wish to discuss the application of Revenue Ruling 2025-4 in greater detail, please contact us.

Revenue Ruling 2025-4 generally provides that if the subject state requires both employers and employees to contribute to the state’s PFML fund then for federal tax purposes:

• The required contribution from the employee is included in their wages and subject to income and employment tax withholding.
• If the employee itemizes their deductions as opposed to taking the standard deduction, the employee may deduct the required contribution as a state income tax paid on the employee’s Form 1040 federal tax return subject to the state and local tax (SALT) deduction limitation.
• Employers may deduct their contributions under IRC § 164(a) as an excise tax paid or accrued in carrying on its trade or business.

If the employer pays the employee’s portion in addition to their own required contribution:

• The employee’s portion of the required contribution is still included in the employee’s gross income and the employee may still deduct the contribution as a state income tax paid on the employee’s Form 1040 federal tax return subject to the state and local tax (SALT) deduction limitation.
• The employer may still deduct their required contribution and may also deduct the employee’s portion as a compensation expense under IRC §162(a). The employer must report their payment of the employee’s portion in wages on the employee’s Form W-2.

Tax treatment of payments received:

Family Medical Leave:

• An employee who receives state-paid family leave payments must include those payments in their gross income. This is because the money received is not related to the employee’s own illness or injury. The income is subject to FIT but is not reportable as wages subject to FIT withholding (“FITW”), FICA, and FUTA.

Medical Leave:

• An employee who receives state-paid medical leave payments must only include in gross income the amount attributable to the employer’s contribution. This portion of the payment is considered to be regular wages and is subject to FIT, FITW, FICA, and FUTAS. The amount of money received that is attributable to the employee’s contribution is excludable from the employee’s gross income and wages and as such is not subject to FIT, FITW, FICA, and FUTA.

**This Dilworth Paxson alert was prepared with the assistance of Trusts & Estates Group  Intern, Kara Coxe.**