The One Big Beautiful Bill Act (OBBBA) substantially expanded the employer childcare credit starting in 2026. The maximum annual credit has been increased by up to 400 percent, and more types of childcare expenses can qualify. It is also now possible for small businesses to work jointly to provide childcare support to their employees and obtain the credit.
What Is the Employer Childcare Credit?
The employer childcare credit is a non-refundable general business credit for certain childcare expenses a business pays for its employees. Expenses that qualify for the credit include:
- The costs of acquiring, constructing, rehabilitating, or expanding an on-site qualified childcare facility
- The costs of operating an on-site qualified childcare facility (including training costs, compensation for employees, and scholarship programs)
- The costs of contracting with an off-site qualified childcare facility to provide childcare for employees
- The costs of contracting with an "intermediate entity"—that is, a third party—that contracts with one or more qualified childcare facilities to provide childcare services
- The cost of childcare referral services
A qualified childcare facility can't be located in a part of the principal residence of the employer or an employee of the business. It can be located in a third party's principal residence if it qualifies as a childcare facility under state and local law. The childcare facility must be licensed and must generally have childcare as its principal purpose.
The use of a qualified childcare facility and the provision of childcare referral services cannot discriminate in favor of highly compensated employees—those who earn more than $160,000 or own more than 5 percent of the employer business.
Beyond On-Site Facilities
There is a common misconception that the employer childcare credit benefits only businesses that construct and operate on-site childcare facilities. This is not true.
The credit is also available to help defray the cost of contracting directly with local off-site providers—for example, preschools and day cares—to offer childcare for employees' children.
Also, starting in 2026, businesses can partner with third-party platforms or organizations that connect employers with childcare providers. This makes it much easier for small businesses to take advantage of the credit.
In addition, starting in 2026, businesses can pool resources to contract with licensed childcare providers, or can jointly own or operate a childcare facility, with each claiming a share of the tax credit. This can lower the costs and administrative burden for each business.
How Much Is the Credit?
The employer childcare credit is much larger for 2026 and later years.
For Small Businesses
For small businesses (those with average annual gross receipts during the previous five years of less than $32 million), the credit is 50 percent of qualified childcare expenditures, up to a maximum annual credit of $600,000.
For example, a business with $100,000 in childcare expenses can claim a $50,000 credit.
For Large Businesses
For large businesses, the credit is 40 percent of childcare expenditures, up to a $500,000 credit per year.
These amounts will be adjusted for inflation for 2027 and later.
The credit is limited to 10 percent of childcare resource and referral expenses.
Compared to Previous Years
For 2025 and earlier, the credit was limited to 25 percent of childcare expenses, up to a maximum annual credit of $150,000. Thus, the maximum credit for 2026 and later is up to four times larger.
Credit Limitations
The employer childcare credit is part of the general business credit, a collection of more than 30 credits. A business's total general business credit is typically limited to 75 percent of its tax liability, with any excess credit eligible for a one-year carryback or a 20-year carryforward.
Employers may deduct as a business expense qualifying childcare expenses that don't qualify for the credit. For example, if a small business spends $25,000 for employee childcare in 2026 or later, it may take a $12,500 credit and deduct the remaining $12,500 as a business expense.
How Small Businesses Can Benefit
Any business, no matter how small, can qualify for the credit if it has legitimate W-2 employees and pays for qualified childcare expenses for them. This includes sole proprietors and single-member LLCs, partnerships, multimember LLCs, and corporations.
Sole Proprietors and Single-Member LLCs
Sole proprietors and single-member LLC owners taxed as sole proprietors cannot take the credit themselves because they are not employees of their business. A sole proprietor who hires one or more employees and incurs qualified childcare expenses for them can claim the credit.
Example: Sid, a sole proprietor consultant whose business earns $200,000 per year, hires his wife, Jan, as his sole W-2 employee to work as his administrative assistant. He pays $20,000 per year for day care for their child. He may claim a $10,000 employer childcare credit and deduct the remaining $10,000 as a business expense.
Partnerships and Multi-Member LLCs
Partners in partnerships and members of multi-member LLCs that are taxed as partnerships are not employees of the business and may not claim the childcare tax credit for themselves. They may claim the credit if they incur qualified childcare expenses for employees of their business.
The credit passes through the partnership or LLC, is allocated among the partners or LLC members, and is reported in the "credits" section of each owner's Schedule K-1.
S Corporations
S corporations with one shareholder-employee can qualify for the credit—the sole shareholder is a W-2 employee of the corporation.
Do Employees Have to Pay Tax on Childcare Benefits?
When an employer provides an employee with childcare, the dollar value of the care is treated as taxable income for the employee and is subject to both income and employment taxes. The amount must be categorized as compensation by the employer and reported as such on the employee's W-2 (in boxes 1, 3, and 5).
The DCAP Exception
But there is an important exception: an employer can establish a dependent care assistance program (DCAP) and provide up to $7,500 in childcare benefits per year ($5,000 in 2025) to employees tax-free. This requires a formal written plan and is subject to strict non-discrimination rules that many small businesses can't meet.
DCAPs may be used to pay childcare expenses for children under 13 or for dependents of any age who are unable to care for themselves.
DCAPs may be used for any expense for a service that allows an employee to work, including day care, babysitters or nannies, or nursery school or preschool. The employer can reimburse employees for dependent care expenses, make payments to third parties for dependent care expenses, or provide an in-house dependent care facility.
DCAP Non-Discrimination Rules
For a plan to qualify as a DCAP, it must satisfy the following non-discrimination rules:
- No more than 25 percent of the benefits may be paid to principal shareholders or to owners who own more than 5 percent of the business's stock or capital or the profits' interest—this includes benefits provided to such owner's spouses and dependents
- The plan must not discriminate as to contributions or benefits
- The plan must not discriminate as to eligibility
- The plan must satisfy the 55 percent benefits test—that is, non-highly compensated employees must receive at least 55 percent of the average employer-provided benefit for highly compensated employees
How Owners Suffer Discrimination but Win
The 25 percent rule eliminates single-shareholder S corporations. The owner-employee of such a corporation must include in taxable employee income the full value of any childcare benefits the corporation pays. This reduces the benefit of the employer childcare tax credit, but the S corporation owner can still come out ahead.
Example: Mary, a solo CPA, is the sole shareholder of her S corporation and works as its only employee. She has one five-year-old child and has her corporation pay $20,000 for licensed day care during the year. Her corporation qualifies for a $10,000 employer childcare tax credit.
But she must include the entire $20,000 childcare payment in her employee income. Since she owns more than 5 percent of the corporation and receives 100 percent of the childcare payments, the care cannot qualify for tax-free treatment under a DCAP.
She and her corporation must pay $7,480 in income and employment tax on the $20,000. Since the $10,000 credit reduces her tax by $10,000, she still comes out ahead by $2,520.
Her corporation can also deduct $10,000 of her childcare expense, which saves her an additional $3,940 in tax. Her total tax savings are $6,160.
What about the sole proprietor in our example above, who hires his spouse as a legitimate employee? Their DCAP fails the non-discrimination test as well because 100 percent of the benefits are going to the spouse of an owner who owns more than 5 percent.
A small business can utilize a DCAP only if at least 75 percent of the benefits go to employees who are not principal owners and are not their spouses or dependents.
Nevertheless, a sole proprietor who pays $20,000 in childcare expenses for a spouse-employee and takes a $10,000 credit will save $6,160 in tax, the same as the owner of a one-shareholder S corporation.
Key Takeaways
- Bigger Credits: Starting in 2026, small employers can claim a tax credit equal to 50 percent of what they spend for their employee's childcare expenses, up to a maximum of $600,000.
- Qualifying Expenses: Childcare expenses that qualify for the credit include the cost of (a) establishing and operating an on-site childcare facility, (b) contracting with third-party off-site childcare providers, (c) contracting with intermediate entities (such as online platforms) to provide childcare, and (d) paying for childcare referral services.
- Pool Resources: Starting in 2026, businesses can pool resources to contract with licensed childcare providers, or can jointly own or operate a childcare facility, with each claiming a share of the tax credit.
- Tax Treatment: The value of childcare benefits must be included in employee income unless the benefits are provided under a DCAP. But such programs are subject to strict non-discrimination rules that eliminate many small businesses (albeit they still come out ahead because of the tax credit).