How Paid Family Leave Complicates Taxes for Employers

There are now six states that, along with the District of Columbia, mandate paid family leave (PFL) benefits to qualifying employees. These six states and the District have created systems whereby both employers and employees pay into PFL programs for the purposes of providing continuity of pay when an employee has to take time away from work to attend to family matters.

PFL seems simple enough in principle. But in reality, it is anything but. A PFL benefit creates additional tax burdens for employers already struggling with payroll taxes, withholding, and compliance. It would not be a surprise to see new PFL mandates in other states drive more companies toward abandoning in-house payroll in favor of outsourcing.

Taxes on PFL Contributions

Each of the six states offering mandated PFL require employees to contribute to their state programs. The District of Columbia does not. Employees in the six states contribute to PFL in a way that is similar to their contributions to state unemployment insurance. The big difference is in how taxes are applied.

Contributions to PFL programs are post-tax contributions. In other words, employers withhold federal and state income taxes, FICA, and unemployment taxes first. Then they deduct contributions for a variety of additional benefits, including PFL. That means the money being contributed to the PFL program is taxed as well.

Taxes on PFL Benefits

All of the jurisdictions mandating PFL, with the exception of Rhode Island, pay out benefits from government coffers. When the employee begins to receive benefit payments, those payments come directly from government in much the same way as unemployment and welfare payments. As such, no withholding is required from the employer.

As to whether or not those benefits are taxable, the answer is both ‘yes’ and ‘no’. Neither FICA nor federal unemployment taxes are levied on PFL. Federal and state income taxes are. This creates a curious situation that amounts to double taxation. The employee’s portion contributed to state programs is taxed at the time the employee is paid. Received benefits are also taxed at the time of receipt.

For the record, states may withhold income taxes on request. Otherwise, beneficiaries pay the taxes when filing their annual returns.

Employer-Sponsored PFL

PFL can be especially challenging when employers decide to offer the benefit voluntarily, explains Dallas-based BenefitMall. The problem here is that the IRS has not made any definitive rulings about whether PFL benefits are subject to tax. BenefitMall agrees with other experts who urge employers to take a conservative approach.

Assume voluntary PFL is just like health insurance, 401(k), and other benefits. Report benefits in the same way. Handle withholding the same way as well. Plan on PFL benefits being subject to federal and state income taxes, FICA, and unemployment taxes.

Maintaining Compliance

At the core of this entire discussion is the idea of compliance. Whether your company offers PFL as a matter of legal requirement or on a voluntary basis, it’s important that all withholding and tax issues be addressed the right way. Compliance is not an option.

BenefitMall says that any trouble maintaining compliance is a good indication a company needs the assistance of a third-party payroll provider. Maintaining compliance is one of the benefits of outsourcing payroll.

Companies that choose to continue doing payroll in-house should at least be working with experienced attorneys or accountants who understand compliance issues relating to PFL. Also be aware that growing numbers of states are looking at implementing PFL mandates as well. What affects only six states and the District of Columbia right now could eventually spread all across the country.