Payroll Compliance Alert: IRS PFML Updates and Proposed Tax Relief for Tips and Overtime Pay

IRS Updates on Paid Family and Medical Leave and Proposed Tax Relief for Tips and Overtime Pay

IRS ruling clarifies taxability of employer and employee contributions to state PFML programs, while the new president suggests income tax cuts to tips and overtime.

Table of contents

1. State Topics
2. Recent IRS Revenue Ruling on State Paid Family and 
3. Medical Leave (PFML) plans
4. Secure ACT 2.0 - Nationwide
5. Trump Administration ideas

Several critical tax and compliance trends are shaping the payroll industry in 2025. Federal and state developments are influencing employer responsibilities, payroll processing, and compliance requirements. This article describes  a few states’ new Paid Family and Medical Leave (PFML) plans,, recent IRS guidance, legislative proposals, and state-level initiatives impacting payroll tax and compliance and how to prepare for the changes. In addition, the article details the Secure ACT 2.0 and the Trump Administration’s ideas for reducing tax for some workers.

State Topics

Thirteen states and Washington, DC have introduced mandatory paid family leave plans. Ten additional states adopted voluntary systems to provide paid family leave via private insurance. Of the 24 (including the District of Columbia) total state leave laws, only 20 are in effect. Most of these state laws provide parental and family caregiving leave, along with temporary disability insurance to reimburse personal medical leave. Here are updates for three states that have introduced legislation to adopt PFML plans.

Maryland

On January 16, 2025, SB 355 was introduced. If passed, this bill would delay the implantation of the Maryland State Paid Family and Medical Leave (PFML) plan. Payroll contributions would begin January 1, 2027 instead of July 1, 2025.  HB 824 was introduced to delay benefit payments to claimants. If passed, benefit payments would begin July 1, 2027 instead of July 1, 2026. 

Effective Date: PFML will go live on July 1, 2025  

Maryland will launch a new paid family and medical leave program. As of July 1, 2026, workers will receive job protection and take time away from work to care for themselves or family members.

• Workers will receive job protection and be able to take time away from work to care for themselves or a family member beginning July 1, 2026.
• The contribution period for the State Plan begins on July 1, 2025, and payroll deductions will also start that day.
• Benefits begin on July 1, 2026.

Update: The contributions employers remit to the State will create a trust fund. The fund will grow over time and be ready to pay out benefits to Maryland workers as of July 1, 2026.

State plan contribution rates will depend on payroll size. Companies with 15 or more employees will have a rate of 0.90% of covered wages, up to the Social Security cap. Employers may withhold up to half (0.45%) of the contribution rate from the employee's pay.

For companies with fewer than 15 workers, the rate will be 0.45% of covered wages up to the Social Security cap. Employers may withhold up to this full amount from the employee's pay.

While the Department of Labor sets the contribution rate for the State Plan, private plans will set their own rates. Employees can’t be charged more in a private plan than through the State Plan.

Minnesota 

Effective Date: PFML is set to go live on January 1, 2026, but the legislation has not been approved yet and the date may change.

• Employee and employer contributions begin January, 1 2026. Minnesota bill HF 11 delayed Minnesota Paid Leave Law implementation delayed by one year. 
• In February and early March, the Minnesota Senate introduced bills SB 1771l SF 2277 that would repeal the Minnesota Paid Leave Law and all unspent money in the family medical leave account returned to the general fund. In place of the repealed law, the bill would establish a new Family and Medical Benefit Insurance Program, administered by the commissioner, which includes updated eligibility criteria, application processes and benefit calculations. The bill also introduces a Family and Medical Benefit Insurance Division. The bill details the appeals process for denied claims, the repayment of overpaid benefits and the collection of amounts due under the new program. 

Update: The state’s “premium rate for the program's first year, 2026, has not been set," according to Minnesota state’s paid leave employer FAQ. “The premium rate will be set each year, subject to a maximum set in state law.” 

Paid leave for 12 weeks is granted for these reasons: the employee's own serious medical condition, parental leave to bond with a new child, providing care for a family member with a serious health condition, safety leave, and leave necessary for a family member’s military deployment.

The premiums will be due on a wage base up to the same limit as federal Social Security tax.

Minnesota’s new PFML program includes retroactive reporting requirements that employers may find perplexing. Wages and the number of employees must be reported dating back to January 1, 2024, though premium collections will begin later in the year. The retroactive element may lead to administrative headaches, requiring companies to maintain detailed payroll records and possibly need to adjust past reporting. Employers' added burdens will include meeting the deadlines and may entail consulting lawyers or accountants to navigate the new requirements.

Oregon

Effective Date: January 1, 2025

Update: Senate Bill 1515, which took effect July 1, 2024, eliminated redundancies between Paid Leave Oregon and the Oregon Family Leave Act. New rules that took effect January 1, 2025, clarify benefits information under Paid Leave Oregon. Paid Leave Oregon provides wage replacement benefits to eligible employees who require time off from work for qualifying reasons. Employees may be eligible if they are ill or sustain an injury and can't work. The benefit includes pregnancy. The plan also allows employees to take leave to bond with a new child, care for a family member with a serious health condition, or to address several additional  issues: domestic violence, sexual assault, harassment, stalking, or bias crimes.

Oregon's employers can either participate in the state-run program (Paid Leave Oregon), self-insure, or fully insure with an equivalent plan.

A few changes were made to Paid Leave Oregon. For example, an employee taking Paid Leave Oregon can tap accrued sick leave, vacation or other employer-provided paid time off (PTO) benefit so the wage-replacement benefit equals full-wage replacement. 

Both the Withholding Tax Formulas and W-4 Instructions were revised at the end of 2024 for the 2025 tax year. There were discrepancies in the standard deduction and allowance amounts. California had a similar discrepancy but quickly released new forms and instructions. We have contacted the Oregon Department of Revenue for clarification, but have not yet received a response about their plans. 

 Standard Deductions

• Single or Married Filing Separately: $2,835
• Head of Household: $5,670
• Married Filing Jointly or Qualifying Surviving Spouse: $5,670
• Value of One Allowance: $256

Oregon W-4 Withholding Statement and Exemption Certificate 

Standard Deductions

• Single or Married Filing Separately: $2,800
• Head of Household: $4,500
• Married Filing Jointly or Qualifying Surviving Spouse: $5,600
• Value of One Allowance: $250

Recent IRS Revenue Ruling on State Paid Family and Medical Leave (PFML) plans

A new ruling was announced in early 2025 regarding the federal taxability of employer and employee contributions to state PFML programs, along with the federal regulations and guidance surrounding this issue.

Provisions of New IRS Ruling

The ruling responds to states’ requests to clarify the federal tax treatment of state-paid leave programs. The programs assist in paying employees who miss work due to non-occupational injuries to themselves or family members, and illness or disabilities. 

Many states have enacted new paid family leave programs in the past few years. A common question has been what is the correct federal payroll tax treatment for employee and employer contributions. Another question is if employer contributions to such programs would be considered taxable compensation for the employee.

Rev. Rul. 2025-4 provided some clarification about taxability. Generally, if the employer decides to pay part of the employee’s share of PFML premiums for a state program, that would be considered taxable income for FIT, Social Security, Medicare, and Federal Unemployment (FUTA) taxes. 

The amount employers contribute to mandatory paid family and medical leave programs is deductible, similar to a payment of excise tax. Likewise, employees can deduct their contributions as income tax payments if they itemize deductions. However, the employee’s deduction for state income tax can’t exceed their state tax deduction limitation.

• The IRS writes that 2025 is a transition period for the new taxability rules, and comments can be provided through April 15, 2025, with taxability taking effect as of January 1, 2026.
• State (SIT) income tax guidance is not defined in the IRS ruling; it is just federal at present..
• The IRS is soliciting comments electronically and the comment section can be accessed on this IRS page.on additional situations and aspects of state-paid family and medical leave programs that are not covered in Rev. Rul 2025-4 

How does this affect payroll tech providers?

The IRS's new ruling provides guidance to payroll tech providers about employers’ tax treatment of contributions and benefits under state-paid family medical leave (PFML) programs and reporting requirements. Overall, employers can deduct their contributions to mandatory paid family and medical leave programs “as a payment of excise tax,” according to the IRS. Based on this ruling, employees’ share of state PFML premiums would need to be included in taxable wages subject to withholding. The revenue ruling also provides transition relief to the District of Columbia, states and employers from certain withholding, payment and information reporting requirements for state paid medical leave benefits made this year.

Secure ACT 2.0 - Nationwide

The SECURE (Setting Every Community Up for Retirement Enhancement Act) 2.0 act was enacted three years ago to make retirement benefits more accessible to more workers, including part-time employees. Regular updates—including one effective at the beginning of 2025—continue to be implemented to improve eligibility, allowances, and ease of enrollment.

Starter 401k plans

A Starter 401(k) is a deferral-only retirement plan that employers who do not currently sponsor a retirement plan can offer to their employees.

Automatic enrollment

These plans generally require automatic enrollment of all eligible employees at a deferral rate of 3 to 15% of their compensation. Employees can opt out or change their contribution level.

Contribution Limits

Annual deferral limits for a Starter 401(k) are $6,000 for 2025, with an additional $1,000 catch-up contribution for those 50 and older.

No Employer Contributions

Employers are not required (or permitted) to make matching or nonelective contributions to a Starter 401(k).

Exemption from Certain Rules

Starter 401(k) plans are exempt from certain nondiscrimination and top-heavy testing requirements. Nondiscrimination and top-heavy testing refer to checks the U.S. government conducts to ensure that plans do not benefit company owners (key employees), or highly-compensated employees compared to non-highly-compensated employees. As a result, to ascertain if a 401(k) plan isn’t discriminating or promoting one group of employees, it must pass a few annual tests. The company offering its employees the 401(k) conducts the tests.

Other Qualified Plans 

If an employer offers a Starter 401(k), they cannot maintain another qualified plan.

Effective Date

Employers can offer Starter 401(k) plans for plan years after December 31, 2023.

Key Points for Employers to Consider

• Starter 401(k) plans assist small businesses in offering retirement benefits to their employees without the complexities of traditional 401(k) plans.
• Automatic enrollment can significantly increase employee participation in retirement savings.
• Employers should know the specific requirements and limitations of Starter 401(k) plans to ensure compliance.
• It’s important to note that this information is based on the provisions of the SECURE Act 2.0 and may not cover all aspects of Starter 401(k) plans. Employers should consult with a qualified financial advisor or legal professional for specific guidance related to their situation.

Trump Administration ideas

Proposal to make tips exempt from federal income tax

Employers must pay servers who earn at least $30 per month in tips a minimum hourly wage of $2.13, according to federal rules. The employer must boost the cash portion if the combined wage and tips don't add up to the federal minimum wage. Salary.com reports that the bottom 10% of services earn $15,954 annually, while the top 10% take home $26,486. 

Congress must decide whether to extend trillions in expiring tax cuts for individuals and small businesses this year, a debate that is split among party lines. However, there is bipartisan support for one tax cut proposal, exempting tips from federal taxes. During the presidential campaign, Donald Trump first suggested the idea, and then Vice President Kamala Harris agreed with it.

Early in the year. Sen. Ted Cruz (R-Texas) introduced S. 129, a bill to amend the Internal Revenue Code of 1986. The bill recommends eliminating income tax on qualified tips through a deduction allowed to “all individual taxpayers, and for other purposes.” 

If Congress were to enact a no taxes on tips proposal into law, they could take several approaches:

• 1. Change the definition of tips in the Internal Revenue Code so tips are not treated as income at all. The downside of this approach is that it may reduce workers’ Social Security benefits.
• 2. Continue to define tips as income, but provide for a tax exemption or exclusion; or 
• 3. Continue to define tips as income and initially include tips in taxable income, but provide for a deduction when the taxpayer files their taxes in the spring.

General thoughts: There is certainly more to come on this. We at Symmetry will watch the developments closely for impact on our clients and products. Depending on how legislation is enacted and implemented, there may or may not be changes at a federal income tax withholding level. 

Proposal on making overtime wages exempt from federal income tax 

During the presidential campaign, then-candidate Donald Trump proposed eliminating tax from tips, Social Security benefits, and overtime pay. In January, Rep. Ross Fulcher (R-Idaho) introduced the “Keep Every Penny Act of 2025,” which proposes to amend the IRS Code to exclude overtime pay from gross income for tax purposes. The bill recommends adding a new section to the tax code to exempt overtime wages from taxable income. 
Overtime pay is regulated in Section 7 of the Fair Labor Standards Act (FSLA) of 1938, requiring employers to pay non-exempt employees at least 1.5 times their regular hourly rate for time worked beyond 40 in a work week. Employees' overtime earnings accrue federal income tax, as well as Social Security and Medicare taxes. Once the bill becomes law, employees will no longer have to pay tax on that overtime work. 

There is some confusion with the taxation of overtime after legal challenges to the Department of Labor’s July 2024 overtime ruling. The overtime tax rule would have increased the minimum salary ceiling for overtime time to $58,656 as of January 1, 2025. On November 15, 2024, the U.S. District Court for the Eastern District of Texas vacated the Department’s 2024 final rule. As a result, the Department of Labor has decided to continue to apply the 2019 rule’s minimum salary level of $684 per week (or $35,568 per year) and a total annual compensation requirement for highly compensated employees of $107,432 per year.

Lawsuits regarding the 2024 final rule are pending in two other federal district courts, and the United States has filed a notice of appeal from the November 15 decision. 

The proposed law about exempting overtime pay from tax does not specify if employee-side payroll taxes (6.2% for Social Security and 1.45% from Medicare) would not be collected, along with income tax.  Also, it is unclear if the bill would eliminate all overtime income taxes or just the 50% overtime premium.