The childcare affordability crisis is fast becoming a retention crisis for employers. High childcare costs make it hard to keep talent, and for both employers and employees, the math often doesn’t work.
This dynamic may begin to shift with the enactment of the One Big Beautiful Bill Act (OBBBA). By significantly expanding both the Employer-Provided Childcare Tax Credit under IRC §45F and the Dependent Care Assistance Program under IRC §129, the law reduces out-of-pocket childcare costs for working parents while increasing employers’ incentives to invest in childcare solutions.
Key tax provisions related to childcare include:
- Employer Provided Childcare Tax Credit – IRC §45F
- Dependent Care Assistance Program – IRC §129
- Dependent Care Credit – IRC §21
OBBBA-enhanced childcare credits may provide benefits beyond tax savings. They may ease childcare pressures, improve retention, and strengthen workforce stability.
Increased Credit Amounts
Employer-Provided Childcare Tax Credit (IRC §45F)
Prior to OBBBA, Section 45F provided businesses with a tax credit equal to:
- 25% of qualified childcare facility and operating expenses
- 10% of qualified childcare resource and referral expenses
- capped at $150,000 annually.
OBBBA substantially expands this credit beginning in 2026. The revised Section 45F now allows:
- 40% of qualified childcare expenditures, up to $500,000 annually
- 50% of expenditures, up to $600,000 annually, for eligible small businesses.
Looking ahead, all credit limits are set to be indexed for inflation starting in 2027 to ensure the credit maintains real value over time.
Qualified Childcare Facility and Operating Expenses
To qualify for the credit, employers must direct expenses toward the purchase, construction, or expansion of a childcare facility, its daily operating costs, or payments to qualified third-party childcare providers. Under the OBBBA, the credit has been expanded to include “a contract with an intermediate entity that contracts with one or more qualified childcare facilities to provide such childcare services.”
Qualified Childcare Resource and Referral Expenses
The credit also covers, albeit at a lower percentage, resource and referral services, which are programs and services that help employees find available childcare openings in their community.
Regardless of the model employers choose, all facilities must meet applicable state and local licensing requirements. If the employer’s primary business is providing childcare, the credit is only available if at least 30% of the enrollees are dependents of company employees.
Dependent Care Assistance Programs (DCAP – IRC §129)
Separate from the 45F credit, employers may also offer a Dependent Care Assistance Program (DCAP) under §129. The DCAP allows employees to set aside pre-tax income for qualifying childcare and certain elder care expenses. This is typically offered through an FSA arrangement, as part of a cafeteria plan.
Historically, the annual exclusion has been limited to $5,000 per household ($2,500 for married individuals filing separately). Beginning in 2026, OBBBA increases this exclusion to $7,500 per household.
Individual Child and Dependent Care Tax Credit (CDCTC – IRC §21)
Separate from the employer-focused provisions described above under §45F and §129, there is also the Child and Dependent Care Tax Credit (CDCTC) under §21. Before OBBBA, the CDCTC allowed taxpayers to claim up to 35% of qualifying dependent care expenses, with the percentage phasing down based on Adjusted Gross Income (AGI). Eligible expenses were capped at $3,000 for one qualifying individual and $6,000 for two or more.
OBBBA partially expands the dependent care tax credit permanently, increasing the maximum applicable percentage of dependent care expenses from 35% to 50%, while the maximum expense cap remains unchanged. The increased credit percentages still phase down based on AGI, as under prior law.
Eligibility and Compliance Requirements
To remain eligible for the credit under IRC Code §45F, businesses must strictly comply with the statutory requirements of the section. This includes adhering to nondiscrimination rules that ensure benefits are available to all employees and do not unfairly favor higher-income employees. Under the Code, discrimination in favor of higher-income employees would cause a facility to lose its status as a qualified childcare facility for the purposes of the credit, and any payments to it would not be eligible for the credit. Employers must also maintain detailed documentation, such as provider identification, licensing paperwork, and contemporaneous records of all qualified expenses.
Additionally, small businesses must verify they meet the gross receipts threshold—typically an average of $31 million or less over the prior five years—to qualify for the higher 50% credit rate.
For employers, the increased limit on the annual exclusion to the Dependent Care Assistance Program (DCAP) may enhance the competitiveness of the benefit and employee participation. However, it heightens compliance considerations as DCAPs also remain subject to nondiscrimination testing. If highly-compensated employees disproportionately benefit from the increased limit, the plan could fail testing, causing benefits for those employees to become taxable.
For both aforementioned credits, employers should review plan design, contribution patterns, and workforce demographics to ensure compliance.
Structuring Employer-Sponsored Childcare
Historically, employer-provided childcare programs were built around on-site facilities or arrangements with a single third-party provider, often located near the employer’s workplace. This was in contrast with DCAPs under IRC §129 which have long allowed reimbursement-based structures in addition to direct contracts with childcare providers.
Under a properly structured dependent care FSA, employees may use daycare centers or individual caregivers near their home, provided the care meets statutory requirements and enables the employee to work. Similarly, the expanded Employer-Provided Childcare Tax Credit under IRC §45F now allows employers to claim credit for payments made to intermediaries that contract with one or more childcare facilities. These intermediaries are not restricted in the number or type of facilities they contract with, provided all facilities meet applicable state and local licensing requirements.
When designing programs, employers should consider how §45F, §129, and §21 interact. Expenses for childcare paid by the employer may generate a §45F credit, while employees may elect to exclude eligible benefits under §129. Amounts excluded under §129 generally cannot also be used by employees to claim the §21 credit, so careful coordination ensures both compliance and maximum tax benefit for both employers and employees.
Reporting Considerations
From the employer’s perspective: two primary tax provisions are relevant.
- The Employer-Provided Childcare Tax Credit under IRC §45F is a business tax credit claimed by the employer directly. The benefit allocated to each employee will be reported as taxable income and is subject to income tax and FICA withholding.
- Under IRC §129, a portion of the taxable benefit of §45F can be excluded from the employee’s income, saving FICA taxes for both employee and employer. Moreover, the amount excluded from the employee’s income will still be eligible for the credit under §45F.
To illustrate this interplay of the credits, consider the following example provided by the Congressional Research Service, and updated with the new amounts under the OBBBA.
A employer contracts with a qualified intermediary to provide childcare for its 10 employees and pays $12,000 toward each qualified employee’s childcare expenses. The employer can both (1) apply $120,000 to the §45F credit (10 x $12,000), yielding a credit of $48-$60,000 and (2) exclude up to $7,500 of the $12,000 in expenses from the employees’ wages. If an employee were subject to a 22% income tax rate, the exclusion would reduce their taxes by $2,223.75 ($1,650 in federal income taxes and $573.75 in Social Security and Medicare payroll taxes). The employer’s share of payroll taxes would also be reduced by $573.75 per employee. The remaining $4,500 would be considered part of the employee’s compensation and subject to income and payroll taxes. The employee would not be able to participate in a dependent care FSA, since the $7,500 in expenses that was excluded from their taxable income is the maximum amount that can be excluded under Section §129.
In contrast, if the employer paid the intermediary only $4,500 per employee and allowed the employee to save $7,500 in an FSA, the tax benefit from the exclusion would be the same to the employee and employer as discussed above. However, the amount applied toward the §45F would be $45,000 (10 x $4,500) and the §45F credit amount would be $18-$22,500 (40-50% of $45,000).
From the employee’s perspective:
As noted, the benefit under §45F is taxable to the employee and included in the employee’s wages. Depending on the arrangement of the employer-provided childcare, the employee may be able to exclude a portion of the benefit from his or her wages by making an election during the open enrollment period.
If the employee does not exclude the benefit from his or her wages, then the employee may instead claim the CDCTC under section §21 on their personal return using Form 2441. If, however, the employee does exclude a portion of the benefit from wages, then the credit is correspondingly reduced.
State Conformity with Federal Credits
State conformity to the federal Employer-Provided Childcare Tax Credit under IRC §45F varies by jurisdiction. For example, New York State offers a refundable credit for employers providing qualified childcare facilities or resource and referral services in the state: it is generally 200% of the federal §45F amount, capped at $500,000, making it significantly more advantageous than the federal credit alone.
Note, however, that the federal §45F credit rates and qualifying expenditures were expanded in 2026, which affects the math underlying New York’s 200% conformity amount; employers should verify the current effective rates and definitions under New York law before calculating their expected benefit. As of this writing, it is not clear what NYS position will be. While the NYS code defines its credit as 200% of the federal credit under §45F, it also explicitly delineates the credit’s requirement, naming only the original two from the IRC: 1) qualified childcare facility and operating expenses and 2) qualified childcare resource and referral expenses. Whether the 200% credit will also apply to payments to intermediaries remains to be seen.
In New Jersey, there is currently no state-level counterpart to §45F for employer-provided childcare facilities or referrals. However, Senate Bill S-1837, sponsored by Senator Troy Singleton, would establish a new childcare contribution tax credit for employers subject to corporation business tax or gross income tax, allowing up to $100,000 per taxable period (50% of eligible expenses) for costs such as on-site childcare operations, subsidies, or payments to third-party providers for employees’ children. The bill advanced through the Senate Economic Growth Committee but still remains under consideration. Employers in these states should monitor conformity and proposed legislation, as state incentives can supplement federal benefits under IRC §129 and §45F.
Tax Return Reporting
The Section §45F credit remains a non-refundable general business credit. While it cannot exceed the employer’s tax liability in a given year, unused amounts may be carried back one year or forward up to 20 years. In the case of partnerships or S-Corporations, the employer credit will be reported on the member or shareholder K-1s, respectively, and claimed on the personal return.
For NYS purposes, the credit is fully refundable. The credit is claimed on Form IT-652 or CT-652 and is reported on the member or shareholder K-1s and ultimately claimed on the personal return.
Proven ROI and Strategic Advantages
According to a joint study released in March 2024 by the Boston Consulting Group (BCG) and nonprofit Moms First, US companies that invest in childcare benefits see rewards in recruiting, retention, and productivity. Research on major employers like UPS, Etsy, and Steamboat Ski Resort has shown that investing in childcare benefits consistently yields a positive return on investment. According to BCG’s study, companies across various industries saw returns ranging from 90% to 425% by avoiding the massive costs associated with employee turnover and absenteeism.
Overcoming Underutilization
Pre-OBBBA, few employers utilized the federal Employer-Provided Childcare Tax Credit, when the annual credit was capped at $150,000 and qualifying expenses were limited. By substantially increasing the maximum credit and broadening eligible expenses, OBBBA transforms employer-supported childcare from a niche benefit into a practical tool for recruitment and retention, reducing net costs for employers while enhancing affordability and stability for working parents.
This material has been prepared for informational purposes only, and is not intended to provide or be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.
