IRS Guidance on Family Leave Programs Leaves Further Questions

Recent Internal Revenue Service guidance on the taxability of contributions to benefits from state family leave programs leaves questions unanswered, two practitioners said March 18.

Rev. Rul. 2025-4 provides guidance on the federal tax treatment of state family leave programs, but not private plans, and many employers have private plans in states with such programs, said Ligeia Donis, Esq., a partner at Baker & McKenzie.

Under the ruling, employee contributions must be withheld from wages on an after-tax basis, are included in an employee’s federal gross income and wages for employment tax purposes, and must be reported on Form W-2, Wage and Tax Statement, Donis said. When the employer voluntarily pays part of the employee’s contribution, that is also taxable and must be reported on Form W-2, she said.

The treatment of family leave benefits was the most surprising part of this revenue ruling, Donis said, because the benefits are considered income but not wages. In the ruling, the IRS considers them most similar to Social Security benefits, which have the same treatment, she said.

The ruling also says that states must report family leave benefits on a Form 1099, but does not say which Form 1099, Donis said, though practitioners assume they will use Form 1099-G, Certain Government Payments. Should similar logic apply to private plans, Donis said, the IRS would have to say whether those plans would also use Forms 1099 and whether it would be acceptable to add private plans’ benefit amounts to Form W-2’s Box 1. Donis suggested that employers would likely prefer to report the amount on a Form W-2 through payroll rather than issuing a Form 1099 to an employee through accounts payable.

According to the ruling, although the medical leave benefits are attributable to the employer’s contribution, the state is considered the third-party payor and is responsible for reporting those payments, Donis said. This means that the state would be responsible for withholding taxes, if necessary, as well as paying the employer share of taxes and issuing Forms W-2 unless it transfers the responsibility to the employer, she said. Under the ruling, medical leave benefits attributable to an employee’s contribution are not included in the employee’s income and are not wages or third-party sick pay.

Stephen Tackney, a partner at KPMG, said that the ruling was viewed as phase one of guidance from the IRS on the programs and expected that “we will be lucky if we get phase two this year or next year.” He added that, in his experience, some employers are forgetting to add equity compensation to taxable income for those programs that consider all compensation taxable.

Donis and Tackney spoke at PayrollOrg’s Capital Summit in Arlington, Va.

The revenue ruling also provides that 2025 is a transition period during which employers and states are not required to comply with the new requirements introduced in the ruling.