Minnesota’s Paid Family & Medical Leave (PFML) program is bringing significant changes for employers and employees alike. This article is part of our ongoing series on the program. In previous posts, we’ve explained the employer exemption process, outlined account setup requirements and key deadlines, and provided an overview of Minnesota’s new Paid Leave law.  In this installment, we focus on the tax implications for employers and employees.

As Minnesota prepares for its Paid Leave program, understanding the tax implications is crucial. Here’s a breakdown of key points to help navigate state and federal tax considerations.

Will paid leave benefits be taxed?

Yes, Minnesota Paid Leave benefits are subject to taxes. The IRS issued guidance on Jan. 15, 2025, in Revenue Ruling 2025-4, outlining how paid leave premiums and benefits will be taxed. Minnesota will follow these federal rules when determining taxability.

How premiums affect W-2 reporting

• Minimum contributions only: No change to the employee’s W-2. The employee’s share is withheld but remains taxable for FICA, federal, and state purposes.
• Employer pays more than required: The extra amount is added as taxable wages on the W-2 and subject to payroll taxes.

Employers should confirm payroll systems are set up correctly.

Are premiums tax-deductible?

• For employees: If an employer covers more than the minimum share of the premium, that contribution is treated as additional compensation and is included in the employee’s taxable wages. Employees may deduct this additional premium contribution as a state income tax deduction if they itemize deductions on their federal return, within certain limits.
• For employers: Employers can deduct both the required and any additional premium contributions. If the employer pays more than the minimum required share, that amount is deductible as a business expense and must be included as wages on the employee’s W-2.

For strategic planning, employers may want to review contributions with their tax advisor.

How are paid leave benefits taxed?

• Family leave: Family leave benefits are not considered wages and are not subject to employment taxes. They are reported to the IRS annually, and recipients will receive a 1099 form for their benefits. Employees can also opt to have state and federal taxes withheld.
• Medical leave: Medical leave benefits are taxed differently. Half of the benefits (the portion covered by the employer) are treated as taxable wages. The other half (employee-paid portion) is excluded from taxable income. The employer must treat the employer-funded portion as wages for tax purposes and report it as third-party sick pay on the employee’s W-2, which is subject to federal tax withholding, Social Security, and Medicare taxes.

Employers should communicate these rules to staff to avoid confusion at tax time.

Withholding taxes from paid leave benefits

Employees can choose to have state and federal taxes withheld from their weekly paid leave benefits. The rates are set at:

• 5% for state taxes (Minnesota)
• 10% for federal taxes

These rates are determined by Minnesota state law, not the IRS.

Employers should advise employees of these options during onboarding or benefit enrollment.

Employer responsibilities

Employers must:

• Include taxable medical leave benefits on employee W-2s
• Stay updated with guidance from the state
• Make sure payroll systems handle both premiums and taxable benefits correctly

Many employers find it helpful to work with advisors for ongoing compliance support, such as payroll and accounting services.

In conclusion: Action steps for employers

Minnesota’s Paid Leave program introduces a unique set of tax responsibilities for both employers and employees. By understanding how premiums and benefits are taxed, and knowing the options for withholding and deductions, individuals and businesses can better prepare for the coming changes.

• Review payroll processes to confirm proper W-2 reporting of premiums and taxable benefits.
• Decide whether your business will contribute more than the required minimum.
• Communicate how family leave and medical leave benefits will be taxed.
• Consider engaging professional advisors to navigate compliance with confidence.