IRC 45s: Employer tax credit for paid family and medical leave

Startups and small businesses always seek to provide the best benefits they can afford to attract and retain employees. However, some benefits the Amazons or Googles of the world offer simply are not affordable. The government offers various tax credits to help small employers and startups compete, which are often overlooked.

One such strategy is leveraging the tax credit for paid maternity leave under IRC Section 45S. This credit not only encourages employers to offer paid family and medical leave, including maternity leave, but also provides a substantial financial incentive to do so. Most employers under 50 employees are not required to provide these benefits, so the tax credits are designed to incentivize this behavior while also helping employers retain their employees.

Understanding IRC 45S

IRC 45S provides a tax credit to employers who offer paid family and medical leave to their employees. In practice, we often see employees asking their supervisors if their small startup has a paid maternity policy. More often than not, the founder has not even considered this and goes into panic mode.

If you do not currently have a maternity leave policy for your startup, this can certainly help defray the cost of paying employees on leave.

What are the eligibility requirements?

To qualify for the credit, startups must meet several specific requirements. It is important to work with your tax advisor early on to implement these items and ensure you can maximize this credit from day one.

• Written policy requirement:
  • The startup must have a written policy that provides at least two weeks of paid family and medical leave annually to full-time employees (and a proportionate amount for part-time employees). It is important to distribute this policy to all of your employees and post this in the appropriate company forums. There are several anti discrimination rules, so be sure all employees are aware of this.
  • The policy must ensure that the paid leave is available to all qualifying employees, typically those who have been employed for at least one year. The credit is not applicable to those employees who are employed less than one year.
  • The leave must be after the date of the policy enactment
• Payment percentage:
  • The paid leave must be at least 50% of the employee’s normal wages. For example, if someone earns $5,000 per month, they must be paid at least $2,500 during the leave period to be eligible for the tax credit.
• Employee compensation limits:
  • Employees must have been employed for at least one year and must have earned less than a specified amount in the prior year (for 2024, this is $93,000) or 60% of a highly compensated employee.

Tax credit calculation examples

The credit is calculated as a percentage of the wages paid to qualifying employees during their leave. The base credit is 12.5% of the wages paid if the leave pay is exactly 50% of normal wages.

This percentage increases by 0.25% for each percentage point by which the leave pay exceeds 50% of normal wages, up to a maximum of 25%.

Example 1: Employee paid 50% of normal wages

• Employee’s normal weekly wage: $1,000
• Paid leave wage (50%): $500
• Credit percentage: 12.5%
• Weekly credit: $500 * 12.5% = $62.50

Example 2: Employee paid 75% of normal wages

• Employee’s normal weekly wage: $1,000
• Paid leave wage (75%): $750
• Credit percentage: 12.5% + (25% * 0.25) = 18.75%
• Weekly credit: $750 * 18.75% = $140.63

Example 3: Employee paid 100% of normal wages

• Employee’s normal weekly wage: $1,000
• Paid leave wage (100%): $1,000
• Credit percentage: 12.5% + (50% * 0.25) = 25%
• Weekly credit: $1,000 * 25% = $250

How to maximize the credit for your startup

• Review and update leave policies:
  • Ensure your company’s leave policies are up to date and compliant with IRC 45S.
  • This may involve revising your employee handbook and other official documents to state the terms of paid leave clearly. Employees should be aware of how they will be compensated on leave, and we encourage our clients to analyze their tax credit potential while designing the policy.
• Calculate eligible wages accurately:
  • Track and document the wages paid to employees during their leave periods. This includes maintaining accurate payroll records and calculating the exact amounts paid for qualifying leave for amounts includable as “compensation”.
• Claim the credit correctly:
  • This credit can be highly technical so we do advise working with your tax advisor. The credit is ultimately claimed on Form 8994 (Employer Credit for Paid Family and Medical Leave).
  • Attach this form to your startup’s annual tax return (e.g., Form 1120 for corporations or Form 1065 for a partnership).
    • The credit either offsets corporate income tax (including a carryforward) or will flow to the equity owner’s personal tax returns if they are a pass-through entity.
• Audit proofing documentation:
  • Keep detailed records of all paid leave, including payroll records, written leave policies, and any related communications with employees. Although audits here are rare, we do encourage clients to maintain a separate file for each employee on leave, including supporting documentation of why their leave qualifies under 45S.

45S benefits for startups and small businesses

• Attracting and retaining talent:
  • Data shows paid maternity leave can help your startup or small business attract and retain top talent, which is crucial in competitive industries where employee benefits can make a significant difference.
  • For current employees, founders or CEOs often are not aware of the familial plans of their employees. Being open about this new policy may put certain employees’ fears at ease.
• Financial incentive:
  • The tax credit reduces your overall tax liability, freeing up capital that can be reinvested into your business. However, if your business is a C Corporation and not profitable, this credit will become a carryforward. Do not be discouraged by this, as tax credits are considered an “asset” and can even be looked at during M&A transactions.
  • For passthrough businesses (S Corps, single member LLCs and Partnerships) this will directly reduce ownership’s tax liabilities.

Putting it together

The tax credit for paid maternity leave under IRC 45S offers a valuable opportunity for startup founders to support their employees while optimizing their tax position. The credit, originally designed under TCJA, is codified through 2025 and will likely be extended beyond that. If you believe you previously qualify for this credit, work with your tax advisor to amend prior tax returns and claim the credit retroactively.

By understanding the eligibility criteria, calculating the credit accurately, and maintaining proper documentation, startups and scaling small businesses can take advantage of this lesser-known credit.