Paid Family Leave and Taxes

Posted by Lee Reams Sr. on

Paid family leave (PFL) is a form of compensation paid to eligible individuals who are unable to work because they are caring for a seriously ill or injured family member or bonding with a minor child within one year of the birth or placement of the child in connection with foster care or adoption.

Payments are a form of unemployment (Sec. 85) and reported on a 1099-G. For federal purposes, unemployment is taxable income to the extent it exceeds any basis the recipient might have in the payments (see later). For state purposes, the PFL may or may not be taxable based on a particular state’s treatment of unemployment benefits.  The Tax Foundation provides an overview of state taxation

Generally, PFL programs are funded through payroll taxes levied by the state. In IRS Chief Counsel Advice CCA 200630017 the IRS held that amounts mandatorily withheld by a state government from an employee’s payroll under the PFL program are taxes, under Sec 164(a)(3), and a taxpayer who itemizes his or her deductions can deduct the amounts withheld as taxes (Note: Payments to a private plan would not be tax deductible but would form a basis as discussed below).

In that same CCA, the IRS noted that provisions of Regulation 1.85-1(b)(1)(iii) apply to those who do not itemize their deductions. Thus where taxpayers were unable to deduct the family temporary disability insurance contributions as an itemized deduction, they established a basis and PFL income can be reduced by the accumulated basis.  Regulation 1.85-1(b)(1)(iii) actually says “which is not deductible by the employee”; thus taxpayers subject to AMT would also not be able to deduct the payments as taxes and therefore basis is also created.

As an aside, Regulation 1.85-1(b)(1)(iii) applies both to unemployment compensation taxes and temporary disability insurance contributions, but separately.  The instructions for the 1099-G specifically require unemployment and PFL to be reported on separate 1099-Gs.