OBBBA makes the paid family leave credit permanent

The paid family leave tax credit under Section 45S has been one of the most underutilized employer benefits since its introduction in 2017. Many businesses missed the original window or let the credit lapse during temporary extensions. With the One Big Beautiful Bill Act (OBBBA) now making this credit permanent for tax years beginning after December 31, 2025, employers have a lasting opportunity to reduce their federal tax liability while offering meaningful paid leave to qualifying employees. OBBBA Sec. 70304 does more than extend the deadline. It modifies eligibility rules, expands access for smaller employers, and requires updated written policies that include anti-retaliation protections.

Understanding the Section 45S paid leave credit

The Section 45S credit was enacted as part of the Tax Cuts and Jobs Act (TCJA) in 2017 to encourage employers to offer paid family and medical leave. Congress extended the credit twice before it was set to expire on December 31, 2025. OBBBA Sec. 70304 eliminates the expiration, making the credit a permanent part of the tax code.

Qualifying leave reasons include the birth of a child, adoption, or foster care placement. Leave also qualifies when an employee cares for a spouse, child, or parent with a serious health condition, or when the employee has a serious health condition. Military qualifying exigencies and care for a service member (spouse, child, parent, or next of kin) are also covered.

The base credit rate is 12.5% of qualifying wages when an employer pays exactly 50% of normal wages during leave. For every percentage point above 50% wage replacement, the credit rate increases by 0.25 percentage points, reaching a maximum of 25% at 100% wage replacement. Employers must file Form 8994 with their business return to claim the credit. For guidance on fringe benefit reporting, refer to IRS Publication 15-B.

Beyond extending the credit, OBBBA modified the eligibility requirements. The updated rules expand access, allowing more employers to qualify, particularly smaller businesses that were previously excluded. These modifications make Section 45S one of the most accessible employer tax benefits in 2026.

Are you eligible for the paid leave credit

Eligibility under the updated OBBBA rules requires employers to meet several specific conditions. First, the employer must have a written paid family leave policy that covers all full-time qualifying employees and provides at least 2 weeks of paid leave per year. Part-time employees who customarily work 20 or more hours per week must receive prorated leave under the same policy.

The written policy must include anti-retaliation language. This is a new OBBBA requirement that did not exist under the original TCJA version of the credit. Without anti-retaliation protections in the policy document, the employer does not qualify.

Employees must have been employed for at least one year before their leave generates the credit. Employers may elect to shorten this requirement to six months, but the minimum tenure threshold cannot be eliminated. Newly hired employees do not accrue credit during their first year, regardless of whether the written policy covers them.

There is a critical compensation exclusion. Employees whose prior-year annualized compensation exceeded approximately $96,000 (calculated as 60% of the §414(q)(1)(B) threshold for 2026) do not qualify as eligible employees. Only lower-to-moderate-wage employees generate the credit. Even if the written policy covers all employees, the credit calculation only includes wages paid to those below the threshold.

The credit is not limited to employers covered by the Family and Medical Leave Act. Any employer with a qualifying written policy can claim the credit, regardless of company size or industry. Smaller employers with fewer than 50 employees who are not subject to FMLA can still qualify if their voluntary leave policy meets all Section 45S requirements. This makes the credit accessible to a wide range of businesses that previously assumed they were excluded.

State- and local-mandated leave counts toward determining whether the employer's policy meets the qualification thresholds. However, mandated wages do not generate the credit dollar amount. Only wages paid voluntarily above the state mandate produce the credit.

What to avoid when claiming the credit

The most expensive mistake is claiming the credit on wages paid to employees earning above the approximately $96,000 compensation threshold. These employees are excluded entirely, and including their wages will trigger issues during an audit.

• Missing the one-year employment requirement is another common error. If an employee has been with the company for less than 12 months (or six months under the employer's election), the leave wages do not qualify.
• Failing to include anti-retaliation language in the written policy is a new risk under OBBBA. Employers who have not updated their policies since 2017 need to add these protections before claiming the 2026 credit.
• Claiming credit for state-mandated leave wages is incorrect. While mandatory leave helps meet the policy qualification threshold, the credit dollars only come from voluntary wages paid above the state minimum. Employers in mandatory-leave states need to track state-required wages separately.
• Do not assume this credit is only for FMLA-covered employers. Many small businesses skip the credit because they believe FMLA coverage is required. Section 45S is a standalone provision that applies to any employer meeting the policy and eligibility requirements.

Step-by-step guide to claiming the credit

Follow these steps to claim the Section 45S credit for the 2026 tax year.

1. Adopt or update your written paid family leave policy. Include anti-retaliation language as required by OBBBA. Cover all full-time qualifying employees with at least two weeks of paid leave per year.
2. Identify qualifying employees. Review your roster for employees with at least one year of tenure whose annualized 2025 compensation was at or below approximately $96,000.
3. Verify that your policy meets the wage-replacement threshold. The policy must provide at least 50% of normal wages during the leave period.
4. Track qualifying leave wages separately from state-mandated leave wages. Only wages for voluntary leave above the state minimum generate the credit.
5. Calculate the credit rate. Start with 12.5% and add 0.25% for each percentage point of wage replacement above 50%. At 60%, the rate is 15%. At 100%, the rate is 25%.
6. Multiply each qualifying employee's leave wages by the credit rate.
7. File Form 8994 with your business return.

Calculating your paid family leave credit

Marcus owns a 10-person accounting firm. Six employees earn under $96,000 per year and qualify for the credit. Four employees earn above the threshold and are excluded. Three qualifying employees take paid leave during 2026.

Employee A has a normal weekly wage of $800 and takes four weeks of leave at 60% wage replacement. Leave wages are $480 per week for four weeks, totaling $1,920. Employee B earns $700 per week and takes two weeks at 60% of that, for a total of $840. Employee C earns $650 per week and takes two weeks at 60%, producing $780.

Total qualifying wages across all three employees come to $3,540. At 60% wage replacement, the credit rate is 12.5% plus (10 times 0.25%), which equals 15%. The total credit is $3,540 × 15%, which equals $531.

If Marcus increases to 100% wage replacement for the same leave periods, the numbers change substantially. Employee A's qualifying wages become $3,200 (four weeks at full pay). Employee B's become $1,400. Employee C's become $1,300. Total qualifying wages are $5,900 at the maximum 25% credit rate, producing a credit of $1,475.

The difference between 60% and 100% wage replacement in this example is $944 in additional credit. Employers should weigh the cost of higher wage replacement against the increased credit when designing their leave policies.

Real-world example of the Section 45S credit

Patricia owns a mid-size landscaping company with 25 employees. She has offered informal paid leave for years, but never had a written policy. Under the new OBBBA rules, Patricia formalizes her leave program by drafting a written policy that covers all employees, includes anti-retaliation language, and provides 70% wage replacement for up to six weeks per year.

Of her 25 employees, 18 have prior-year compensation below the $96,000 threshold and at least one year of tenure. During 2026, five qualifying employees take leave for covered reasons, including childbirth, caring for a parent with a serious health condition, and personal medical recovery.

Patricia tracks each employee's normal wages and leave wages separately. She also operates in a state with a two-week paid leave mandate, so she documents which wages are state-required and which are voluntary. Only the voluntary portion generates credit.

Her total qualifying voluntary leave wages for the year are $14,200. At 70% wage replacement, the credit rate is 12.5% plus (20 times 0.25%), which equals 17.5%. Patricia's total Section 45S credit is $14,200 × 17.5%, which equals $2,485. She files Form 8994 with her business return to claim the credit.

Your compliance roadmap for paid leave

Maintaining compliance with Section 45S requires ongoing documentation throughout the tax year. Keep your written paid leave policy on file, including anti-retaliation language. Update the policy annually to reflect any changes in wage replacement rates, leave duration, or employee coverage.

Track each employee's employment start date to verify the one-year (or six-month) tenure requirement. Maintain prior-year compensation records for every employee so you can identify who falls above or below the approximately $96,000 threshold each year.

For each leave event, document the following:

• Employee name and ID
• Dates of leave
• Normal weekly wage
• Wages paid during leave
• Qualifying leave reason

These records support your Form 8994 filing and will be necessary during an audit.

If your business operates in a mandatory-leave state, maintain separate documentation for state-required leave wages and voluntary leave wages. This separation is critical for calculating the correct credit amount and defending the claim during an audit.

Filing your business return with the credit

The Section 45S credit is claimed by filing Form 8994 with your business tax return. Sole proprietors attach it to Schedule C. S Corporations file Form 1120-S. Partnerships file Form 1065. C Corporations file Form 1120.

The credit is nonrefundable, meaning it reduces your federal tax liability to zero but does not produce a refund. Unused credit carries forward under general business credit rules, generally one year back and 20 years forward.

For pass-through entities such as S Corporations and Partnerships, the credit flows through to Individuals owners based on their ownership percentage.

Check State Tax Deadlines for state-specific filing requirements that may affect your planning timeline.

Other tax strategies alongside paid leave

Businesses building comprehensive compensation packages can pair the Section 45S credit with several additional strategies available through Instead.

An Employee achievement awards program allows employers to deduct the cost of tangible recognition gifts for length-of-service or safety achievements. These awards are excluded from the employee's taxable income up to specified limits.

A Qualified education assistance program allows employers to provide up to $5,250 per employee per year in tax-free education benefits covering tuition, fees, books, and supplies.

A Health reimbursement arrangement enables businesses to reimburse employees for medical expenses on a pre-tax basis. The employer deducts the reimbursements while employees receive tax-free benefits.

Employers can also explore Depreciation and amortization strategies for business assets and Home office deductions for qualifying workspaces. Together, these programs reduce total tax costs while improving employee retention.

Turn your paid leave policy into a permanent tax credit

The Section 45S credit is now permanent under OBBBA, but only employers with a qualifying written policy and proper wage documentation can claim it. The difference between a 12.5% and 25% credit rate depends entirely on how much you pay above the minimum rate, which means structuring your policy correctly before the first leave event determines your credit ceiling. Instead's Business platform walks you through policy drafting, wage-tier modeling, and credit calculation, so you file the correct amount on Form 8994 without leaving a single dollar on the table.

Review Instead's pricing plans to start building your Section 45S credit strategy.

Frequently asked questions

Q: Which employees are excluded from the credit?

A: Employees whose annualized compensation in the prior year exceeded approximately $96,000 (60% of the §414(q)(1)(B) threshold for 2026) do not qualify as eligible employees. Leave wages paid to these higher-compensated workers do not generate the credit, even if the employer's written policy covers them.

Q: Does an employer need FMLA coverage to claim?

A: No. Section 45S is broader than FMLA. Any employer with a qualifying written paid leave policy can claim the credit, regardless of whether they are subject to FMLA. Smaller employers not covered by FMLA can still qualify if their voluntary leave policy meets all Section 45S requirements.

Q: Is state-mandated leave counted toward the credit?

A: State-mandated leave wages count toward determining whether the employer's overall policy meets the qualification thresholds, but the mandated wages themselves do not generate the credit dollar amount. Only wages paid voluntarily above what the state law requires produce the credit.

Q: What employment tenure is required to qualify?

A: Employees must have been employed for at least one year before taking leave that generates the credit. Employers may elect to shorten this to six months. Employees hired within the past year do not qualify, even if covered by the written policy.

Q: Is this credit available to all entity types?

A: Yes. The credit is available to all business entity types, including S Corporations, C Corporations, Partnerships, and sole proprietors. For pass-through entities, the credit flows through to the owner's personal return based on ownership percentage.

Q: What if the credit exceeds my tax liability?

A: The credit is nonrefundable. It reduces your federal tax liability to zero but does not generate a refund. Unused amounts carry forward under general business credit rules, generally one year back and 20 years forward.