Taxability of California Paid Family Leave (PFL) benefits

Is California Paid Family Leave (PFL) taxable?

Q:

“My wife and I had a baby last year. I took a few weeks off to spend time with my family. I received some checks from California for the time I was off. I was issued a 1099-MISC by California for the income I received. Is it taxable? I looked on the internet for quite a while on this point because I’d love to save the money.”

A:

The short answer is that all or a portion of it may be taxable on your federal return, but it is not taxable on your California state return.

The benefits you received were from California’s Paid Family Leave (PFL) program which is part of the State Disability Insurance (SDI) program. You pay for the program with automatic deductions from your paycheck. When you have a family circumstance that qualifies, you can apply and receive benefits from the PFL program.

146001171 rotated smallerThe benefits you receive are not taxable on your California return. They are taxable on your federal return. However, most taxpayers do not realize that you are allowed to exclude an amount equal to the non-deductible payments you have made to the SDI program. Generally speaking, this means you can exclude up to the amount of payments you made in years you did not itemize on your federal return.

You might think of it as follows. Each time you made a non-deductible payment into the program you built up “tax basis.” When you receive benefits, the benefits reduce basis and are not taxable. However once basis is reduced to zero any additional benefits that you receive are taxable.

For years in which you itemized, your payments to SDI do not increase your “basis” because you have already received a tax benefit (e.g. the itemized deduction that presumably saved you some tax).

Figuring out your tax basis in PFL benefits takes some record keeping. You will need to review your previous years’ federal returns and make a list of the years for which you did not itemize or receive any benefit from the SDI deduction. Then figure out how much SDI you paid in those years (you should be able to find it on your W-2 or your last paycheck for that year). Add it up, and that’s your tax basis.

If you have received PFL or other benefits under the SDI program in prior years, such benefits may have reduced your basis.

California reports the amount on the 1099 to the IRS. If you report a lower amount or a zero on your return, the IRS may send you a friendly letter letting you know that it disagrees with your return. You may consider heading it off at the pass by including an explanatory statement on your return.

BOTTOM LINE:

Don’t simply put the amount on the 1099 into your federal return. If you do, you may be paying more tax than you owe. If you’ve kept good records it shouldn’t take much time to save yourself some tax.

 

SOURCES:

Treasury Regulation 1.85-1(b)(1)(3)

Chief Counsel Memorandum 200630017

17 Comments
  1. Do you still stand by this post about building up an sdi tax basis? Don’t see it referenced anywhere else online. If so- how many years back would you go? 7 too many?

    • Robyn: Yes the post is still accurate. You’re correct that you won’t find this info online. When I posted it I looked extensively and didn’t find anyone that discussed it. There shouldn’t be any limit how far back you can go.

  2. Hi Jeff, THANK YOU for providing this excellent explanation. The EDD Fact Sheet was ‘unclear’. Have you heard from IRS or anyone that your interpretation above is inaccurate or that SDI contributions not itemized from prior years increase the ‘basis’? Marvin

  3. Hi Jeff,
    Thanks for the excellent post. I completely agree with you, but as somebody else mentioned this is not mentioned anywhere else. In my case, since my company had a VPDI plan none of the payments were ever eligible for itemized deductions. So I can effectively consider all my VPDI payments to date against the PFL benefits this year. Isnt it? VB

  4. VB:
    Just to be clear, VPDI is a private insurance program, unlike PFL which is a state program. Sounds like you received benefits under your VPDI program, not PFL benefits. In any event, the tax treatment should be similar. If you didn’t get to deduct the amounts you paid into the program, then that would be taken into account when you receive benefits.
    I hope that helps.
    Best, Jeff

  5. Hi Jeff,
    Thanks for the blog. It is a rare but valuable information.
    If I am filing as a tax return as married couple joint return and my spouse has PFL payment, can we consider both of our (mine & spouse) SDI contributions towards the basis or only my spous’s SDI contribution to be considered towards the bases as she is the one who got PFL benefit?

    • I have the same question!

    • Vamsi:
      I overlooked your comment until now.
      Great question. It would be nice to include both of your contributions as that would reduce the taxable amount of benefits.
      Unfortunately it’s not a question I can answer off the top of my head. Would require some thinking and analysis.
      Best,
      Jeff

  6. Hi Jeff, this is incredible info here. Thank you. Do you have a recommended way of executing this in Turbo Tax Home and Biz? Is there a special line or form for claiming this deduction? I’d rather not get audited by having a conflicting 1099-G. Also, Do I need to include the previous years W2s as evidence along with a letter? My guess is E-filing is out of the question? Any advice you have would be greatly appreciated. Happy to enlist your services if necessary. Thanks so much.

  7. I just received (03/16/2018) a statement from the California Franchise Tax Board stating I owe them money for PFL income I received in 2013. According to them I owe over 2k. Was PFL tax exempt that year for California income?

  8. Hello,

    My situation is that I may receive benefits this year while I have not built up much tax basis yet. In future years I expect to be paying in without receiving benefits. Could I then deduct the benefits that I received in 2018 on my 2019 federal return for example?

    Thanks!

  9. Hello. I have talked to a couple of tax prep people who haven’t heard of this. So I am just making sure this still stands if I had received $2500 in paid family leave from the state of California but I have paid into SDI through my job. I can deduct the amount I paid into the SDI from the 1099G that the state of California sent me?

  10. Very good post. I’m going through many of these issues as well..

  11. Hello, thanks for the post. Since the last comment was from 2017, I want to confirm if this is still accurate info, and also want to know how the $10k SALT limit would play into this. My line of thinking is that, for 2018 and beyond, some of the SDI taxes paid could still be considered “non-deductible” if you itemized but hit the $10k limit. Thoughts?

  12. Hi Jeff! I know I just stumbled upon this article. My husband and I got the friendly letter from the IRS today. We both received CA PFL after the birth of our oldest child in 2017. They are saying we owe taxes based on this income. We never received a 1099-G so we had no idea. I looked and we definitely have enough to lower our tax basis and then some from what they say we owe. I was wondering if we do use this same explanation for 2019 (we had another baby) and will have the same scenario. For example IRS says we owe $3000, both my husband and I paid roughly $1600/year into SDI (never itemized). Can we say we have paid the $3000 from 2010 and 2011 and then use 2012 and 2013 to explain the reduction in the tax basis we anticipate from 2019? I hope that makes sense!

  13. Is there a IRS form you can use to make an explanatory statement on your return.

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