Ask business owners what keeps them up at night and “finding and keeping good people” tops the list. Ask the employees who quit, and childcare comes up again and again. For years the tax code offered employers only modest help here: a childcare credit so limited that few small businesses bothered with it, and a dependent care FSA capped at $5,000 since 1986.
That changed on January 1, 2026. The One Big Beautiful Bill Act made the Section 45F employer-provided childcare credit far richer and easier for small businesses to use, and it raised the dependent care assistance limit to $7,500 for the first time in four decades. With open enrollment for 2027 weeks away and budgets being set now, this is the moment to decide whether childcare belongs in your benefits package.
What Changed for 2026
| Provision | Through 2025 | Starting 2026 |
|---|---|---|
| 45F credit rate on childcare expenditures | 25% | 40% (50% for eligible small businesses) |
| Annual 45F credit cap | $150,000 | $500,000 ($600,000 for eligible small businesses), indexed after 2026 |
| Resource and referral expenditures | 10% | 10% (unchanged) |
| Pooled and third-party arrangements | Not addressed | Allowed for eligible small businesses |
| Dependent care FSA exclusion | $5,000 ($2,500 married filing separately) | $7,500 ($3,750 married filing separately) |
An “eligible small business” is one that meets the Section 448(c) gross receipts test using a five-year average instead of three years, roughly $32 million for 2026. That covers most practices and family businesses.
How the Section 45F Credit Works
The credit applies to qualified childcare expenditures, which fall into three buckets:
- Facility costs. Acquiring, building, rehabilitating, or expanding property used as a qualified childcare facility for your employees.
- Operating costs. Running such a facility, including staff training and scholarship programs for childcare workers.
- Contracted care. Payments to a licensed childcare facility to provide care for your employees’ children, such as reserving slots at a center near your office.
Most small businesses will use the third bucket. Instead of building a daycare, you can contract with an existing licensed center, and eligible small businesses can now also pay a third-party intermediary that arranges care, or jointly own and operate a facility with other small businesses. Neighboring medical offices, for example, could share a center.
A Worked Example
A Specialty Practice With $9 Million in Revenue
- Contract with a nearby center reserving 10 slots for staff children: $120,000 per year.
- Credit at the 50% small business rate: $60,000, claimed on Form 8882.
- Remaining deduction: $60,000, because expenses used for the credit cannot also be deducted.
- Net after-tax cost at a 37% marginal rate: about $37,800 for a benefit employees value at $120,000.
Under the old rules the same contract produced a $30,000 credit. The credit is part of the general business credit, so unused amounts carry back one year and forward twenty.
Rules You Cannot Skip
- Licensing: the facility must meet all state and local childcare laws.
- Nondiscrimination: enrollment must be open to employees and cannot favor highly compensated employees.
- Recapture: if a facility you built or bought stops operating as a childcare facility or changes hands within ten years, part of the credit is added back to tax on a declining schedule.
- Basis reduction: credits claimed on facility construction or acquisition reduce the property’s depreciable basis.
A credit reduces tax dollar for dollar, which is why a well-structured contract with a local center can cost the business less than a modest raise.
The $7,500 Dependent Care FSA
A dependent care assistance program (DCAP), commonly called a dependent care FSA, lets employees pay for daycare, preschool, before- and after-school programs, and summer day camps with pre-tax payroll deductions. The new $7,500 limit is not indexed for inflation, but it is a 50% jump.
The savings run both ways. Pre-tax contributions escape income tax and FICA for the employee, and the employer skips its 7.65% share of FICA on every dollar deferred.
- Employee in the 22% bracket contributing $7,500 saves about $2,224 in federal income and payroll taxes, plus state tax where it applies.
- Employer saves about $574 per maxed-out participant. Twenty participants means roughly $11,500 a year, usually enough to cover plan fees.
Watch the Nondiscrimination Tests
Two nondiscrimination tests trip up small employers most often: the 55% average benefits test, which requires the average benefit for non-highly compensated employees to be at least 55% of the average for highly compensated employees, and the 25% concentration test, which limits benefits going to more-than-5% owners and their families. The higher limit makes both harder to pass, because higher earners are the ones most likely to elect the full $7,500. Fail, and highly compensated participants lose the exclusion and owe tax on their benefits. Run a mid-year test, and cap HCE elections if needed before the plan year closes.
Coordinate With the Family Tax Credit
Employees cannot double dip. Every dollar excluded through a DCAP reduces the expenses eligible for the personal child and dependent care credit, which is capped at $3,000 of expenses for one child and $6,000 for two or more. An employee who excludes $7,500 will generally have nothing left for the credit. Lower-income employees may do better with the credit, which the 2025 law made more generous, so explain the tradeoff in enrollment materials.
Why Medical Practices Should Move First
Early clinics, late surgery days, and weekend call rarely fit standard daycare hours, and losing one experienced nurse can cost tens of thousands of dollars to replace. Reserved slots at a center with extended hours, paired with a $7,500 DCAP, give your staff a benefit competitors rarely offer, and the 45F credit returns half of the contracted cost. Our medical practice finance team can model the credit against your staffing and turnover numbers.
An Action Plan for Fourth Quarter
- Amend your cafeteria plan document if it still references the $5,000 limit. The higher exclusion only applies if the plan allows it.
- Survey employees on ages of children, current costs, and preferred locations before signing any contract.
- Get quotes from licensed centers for reserved slots or priority enrollment, and confirm the contract language supports a 45F claim.
- Update payroll deduction codes so DCAP contributions are excluded from wages in Box 1 and reported in Box 10 of the W-2. Our payroll team can handle the setup.
- Track expenditures separately in your books so the credit is easy to substantiate at filing time.
Childcare benefits also fit alongside the other tools we have covered this year, including ICHRA health coverage and small business retirement plans, as part of a total rewards package you can actually afford.
The Bottom Line
For the first time, childcare is a realistic benefit for small employers, not just large corporations. A 50% credit on contracted care and a $7,500 pre-tax account can turn a recruiting weakness into a retention advantage, at a net cost well below what the benefit is worth to your team.
Thinking about adding childcare benefits for 2027? Schedule a free consultation and our tax strategy and CFO advisory teams will estimate your credit, review your plan documents, and build the benefit into your 2027 budget.
