New Federal Paid Leave Tax Credit: What California Employers Need to Know for 2026
Paid family and medical leave continues to be a key focus in today’s competitive benefits landscape. While California already mandates paid leave through its State Disability Insurance (SDI) program, federal incentives are expanding, and they could benefit employers in all states, including California. A significant update to the IRC §45S Paid Family and Medical Leave Tax Credit takes effect in 2026, offering new opportunities for eligible businesses to offset the cost of providing paid leave.
Here’s what California employers need to know, and how this evolving credit can support their retention strategy, compliance efforts, and bottom line.
What Is the IRC §45S Paid Leave Tax Credit?
The IRC §45S Paid Family and Medical Leave Tax Credit, introduced as part of the 2017 Tax Cuts and Jobs Act, was designed to incentivize employers to voluntarily provide paid family and medical leave to their employees.
The credit allows eligible employers to claim up to 25% of wages paid to qualifying employees while they are on leave for FMLA-qualified reasons. Initially authorized on a temporary basis, it has since been extended multiple times. Upcoming changes aim to make it more accessible and permanent.
Original Requirements Included:
- Employees must have worked at least one year
- Employers must provide at least two weeks of leave at 50% or more of regular pay
- Leave must meet Family and Medical Leave Act (FMLA) criteria
- Credit was available only on direct wage payments, not premiums for insurance products
What’s Changing in 2026? Key Updates to KnowWhat’s Changing in 2026? Key Updates to Know
Recent legislation will expand and simplify access to the §45S credit beginning in 2026. These updates are particularly relevant to California employers who previously assumed the state program made them ineligible.
1. Permanency of the Credit
Starting in 2026, the §45S tax credit hasbecome permanent, giving employers a longer planning horizon and more incentive to integrate paid leave into their long-term benefits strategy.
2. Shortened Employment Requirement
The length of employment required for an employee to qualify has been reduced from 12 months to 6 months. This change aligns better with the modern workforce, especially for companies with high turnover or seasonal labor.
3. Applies in All States
The revised credit is applicable nationwide, including in states like California that already have mandated Paid Family Leave (PFL). Employers operating across multiple states can now more easily implement a cohesive, federally supported leave strategy.
4. Premiums Now Qualify
One of the most impactful updates is that employers can now claim the credit not only for wages paid directly to employees on leave but also for premiums paid for an eligible private Paid Family Leave insurance policy. This provides greater flexibility for businesses that use insured plans to cover their leave obligations.
Qualifying for the Credit: Eligibility Criteria for Employers
To claim the paid leave tax credit, employers must meet specific criteria. It is not automatic, and documentation matters. Here are the foundational requirements:
- Written Policy: Employers must have a formal, written paid family and medical leave policy that meets IRS standards
- Duration and Pay: Policy must provide at least two weeks of leave (annually) for full-time employees, at 50% or more of their normal earnings
- Income Threshold: The credit only applies to employees earning below a specified income limit (this adjusts annually, so employers should confirm current IRS thresholds)
- FMLA-Qualified Leave: Leave must be for a reason covered under the Family and Medical Leave Act, including bonding with a new child, caring for a family member with a serious health condition, or the employee’s own medical needs
Employers must be prepared to demonstrate compliance with these requirements to claim the credit.
Premiums vs. Wages: Two Paths to Claim the Credit
One of the most notable improvements to the paid family and medical leave tax credit is the expanded eligibility to include insurance premiums.
Employers can now claim the credit based on either:
- Wages paid directly to qualifying employees on leave
- Premiums paid to a qualifying private paid family leave insurance provider
This opens the door for businesses to use insured products, often already in place through disability insurance plans, to help meet compliance and claim credits. The maximum credit remains up to 25% of wages or qualifying premium amounts, depending on the method used.
For businesses with limited HR capacity, using an insured plan to handle claims can reduce administrative burden while still allowing for credit eligibility.
What This Means for California Employers
California has long required participation in its Paid Family Leave program, which provides partial wage replacement through the SDI system. However, California’s state program does not disqualify employers from claiming the §45S credit under the revised rules.
Here is why it still matters for California businesses:
- Employers can supplement the state-mandated benefits with private insured plans that meet or exceed state requirements and may be eligible for the federal tax credit
- Multi-state employers can use the federal credit to create consistency across locations while still complying with California’s rules
- Remote and hybrid teams are more common than ever. Businesses headquartered in California but employing staff in other states may benefit from building a federally aligned leave program eligible for the credit
- Wage replacement through private plans may offer higher benefit levels than the state program alone, boosting employee satisfaction and retention
The key is strategic coordination, designing a policy that meets both state and federal requirements while maximizing financial benefits.
How AEIS Helps Employers Navigate Leave Strategy and Tax Credits
At AEIS, we understand the nuances of state and federal paid leave compliance, and how they intersect with benefits strategy, tax planning, and employee satisfaction.
We help California employers:
- Evaluate private insured paid family leave plans that meet IRS and California guidelines
- Coordinate across states, helping businesses support their remote or multi-state workforces
- Partner with legal and tax advisors to ensure that credit eligibility, documentation, and filings are handled correctly
- Communicate benefit value to employees to boost awareness and retention
For businesses that already offer leave benefits, this credit represents a meaningful way to recapture costs. For those considering how to enhance their leave offerings, it is an opportunity to do so strategically, with federal support.
Disclaimer: Any information related to compliance, laws and regulations, or other subject matters in this blog is intended to be informational and does not constitute legal advice regarding any specific situation. The content of this blog is based on the most up-to-date information that was available on the date it was published and could be subject to change. Should you require further assistance or legal advice, please consult a licensed attorney.
