Payroll in Practice: 6.16.2025

Question: The IRS recently issued Tax Tip 2025-39 to remind employers that they may be eligible for a tax credit worth up to $150,000 for providing child care to their employees. How does this credit relate to the child care credit that taxpayers are allowed on their individual income tax returns?

Answer: The child and dependent care credit helps individual taxpayers cover the cost associated with caring for children or dependents while they work or look for work. The credit is a percentage of the taxpayer’s adjusted gross income up to a maximum of 35% for taxpayers with AGI up to $15,000. It gradually reduces to 20% for taxpayers with AGI over $43,000.

The maximum eligible for the credit is $3,000 for one qualifying dependent or $6,000 for two or more qualifying dependents. This amount is offset by up to $5,000 of the value of any employer-provided benefits reported in Box 10 of Form W-2, Wage and Tax Statement. Employer-provided benefits include those paid from employee pretax contributions to a flexible spending arrangement. Taxpayers compute and claim the credit using Form 2441, Child and Dependent Care Expenses, which is submitted along with the taxpayer’s return.

The employer-provided child care tax credit aims to encourage employers to provide child care services to their employees. The credit offsets 10% of the employer’s costs for providing qualified child care resource and referral services and 25% of qualified child care facility costs. The credit is capped at $150,000 per tax year.

“Qualified child care resources and referral” costs are amounts paid or incurred under a contract to provide child care resources and referral services to employees. According to the US Chamber of Commerce, examples of these services might include helping employees find child care that meets their needs, providing care when their usual care arrangements are disrupted, managing employer-provided subsidy or voucher programs, and negotiating special arrangements with child care providers to give employees access to care, reserved spots, or favorable rates.

A qualified child care facility must comply with applicable laws, regulations, and licensing requirements. In addition, the facility must be used principally for child care, enrollment must be open to employees during the tax year, and access must not discriminate in favor of highly compensated employees. If child care is the principal trade or business of the employer, at least 30% of enrollees must be dependents of the employer’s employees.

“Qualified child care facility expenditures” include the cost to acquire, construct, rehabilitate or expand property to be used as the qualified child care facility. The property must constitute depreciable or amortizable property and cannot be part of the residence of the employer or an employee.

“Operating expenses of the facility” include the costs for employee training, scholarship programs, and employee compensation. The employer may also contract with a qualified facility to provide child care services to employees.

The employer may not receive a double benefit from the child care tax credit, so it must reduce the basis or capital expenditure for the facility, any allowable deductions when calculating the credit, and any expenditures used to figure any other tax credit.

Employers use IRS Form 8882, Credit for Employer-Provided Childcare Facilities and Services, to claim the credit. The credit is part of the general business credit and is subject to the carryback and carryforward rules, which allows employers to apply the previous year’s unused credit in the current year or apply the current year’s unused credit in future tax years.

The value of benefits an employer provides to employees under a dependent care assistance program may be excluded from wages if the plan is in writing and the employer believes the benefits may be excluded from the employee’s gross income.

A single employee can generally exclude up to $5,000 of DCAP benefits from AGI. The benefits must be provided to enable the employee – and, if applicable, the employee’s spouse – to be employed. However, the exclusion cannot exceed either the employee’s or spouse’s earned income, whoever earns less. Special rules apply to determine the earned income of a spouse who is either a student or is unable to care for themselves. These details are explained in IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits.

An employer reports the full amount of DCAP benefits provided to an employee in Box 10 of Form W-2. This includes amounts paid from a dependent care flexible spending arrangement as well as dependent care paid for or provided by the employer that exceed the employee’s pretax contributions. Amounts over $5,000 should also be reported as taxable wages in Boxes 1, 3, 5 and any applicable state and local wage boxes on Form W-2. The employee computes the allowable credit on Form 2441.

This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., or its owners.

Author Information
Patrick Haggerty is the owner of a tax practice in Chapel Hill, North Carolina, and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

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