How to reduce your employees' child care costs

When employers help with child care, it has many good effects. First, it helps families save money. It lowers the cost of child care, so parents can use that money for other important things.

Secondly, it positively recruitment and retention by granting employees:  

• Improved work-life balance; 
• Competitive benefits; and 
• Reduced absenteeism and stress.   

This guide explores three effective approaches to achieve this: utilizing Dependent Care Flexible Spending Accounts (FSAs), providing direct payment as a taxable fringe benefit, and offering child care services in-kind.  

Option 1: Utilizing Dependent Care Flexible Spending Accounts (FSAs)  

Dependent Care FSAs are a versatile option for employees to manage child care costs. By allocating pre-tax earnings into these accounts, employees can pay for eligible dependent care expenses, which can range from full-day child care to after-school programs. While primarily funded by employees, employers can also contribute, increasing the benefit's appeal.  

Typically, the Dependent Care FSA funds cover expenses for the care of children under the age of 13. However, it can also cover expenses for a spouse or a dependent of any age (including children, but also parents) who is physically or mentally incapable of self-care.   

The major advantage of Dependent Care FSAs lies in their tax benefits. Employees’ contributions decrease their taxable income. In 2024, the annual contribution limit is $5,000 for individuals or married couples filing jointly, and $2,500 for a married person filing separately.  

For employers, the appeal of Dependent Care FSAs lies in their dual role as a tax-efficient benefit, since both the contributions and costs are deductible. They also serve as a tool for increasing employee satisfaction by addressing a major family concern: affordable care.  

However, there are two issues with Dependent Care FSAs. Firstly, they typically require time and money to launch and maintain. Secondly, they are subject to a “use-it-or-lose-it” policy, meaning that any unused funds at the end of the calendar year are forfeited.  

Option 2: Direct payment of child care expenses  

Another approach is for employers to directly pay for their employees' child care expenses. In this method, the employer typically provides a set amount each pay-period for child care, such as $200 a month.  

This direct payment method results in a tax deduction for employers. Employers also have greater discretion over how the money is spent. For example, they could limit contributions only to children under five.  

Employees often appreciate this option because of its simplicity and because it doesn’t require them to make contributions to a formal vehicle like a Dependent Care FSA. However, the challenge with direct payment is that these benefits are considered taxable. Therefore, the employee does not receive a tax benefit and the payments are treated the same as any other wages.   

Option 3: Providing in-kind child care services  

The third option involves employers providing child care services directly to their employees at no or reduced cost. This can be done through on-site facilities or by contracting with child care providers.  

Employees typically appreciate this benefit because it is simple to understand and easy for them to access. From a tax perspective, in-kind child care services are generally not considered taxable income for employees, so they do not face an increased tax burden with this option.  

For employers, the cost of providing on-site care can be high. Even a child care business can incur additional costs, such as hiring additional staff to accommodate employees’ children. If you choose to offer care for your employees at your child care business, you’ll want to consider the impacts the additional costs will have on your operations.  

If you are offering on-site care, you may be eligible for tax credits to offset some of these costs if 30% or more of the children cared for are employees’ children. In this case, the employer may qualify for tax credits related to the expenses of operating a child care facility. The credit, known as the Employer-Provided Child Care Credit (Form 8882), offers a percentage of the expenses incurred in operating a qualified child care facility.  

It is important to note that while the costs of providing free or reduced cost care for employees are deductible, the actual discount itself is not. For example, let’s say Claudia owns a small center and provides free care to her ten employees. If she normally charges $1,444.50 per month per child, the benefit means she’s potentially losing $14,445 per month in revenue. However, she cannot deduct this loss. She can deduct the cost of her operations such as paying teachers, food, transportation, etc.   

Let's now compare the pros and cons of these three strategies:  

Don’t worry about “de minimus” benefits  

When talking about employer-provided child care, "de minimis" benefits are things that are so small that it is not worth keeping track of them. The IRS usually does not tax these benefits. But, this idea can be tricky and depends on the situation. Here is how it might work with employer-provided child care:

• Occasional babysitting or emergency child care 
• Small, infrequent benefits (e.g., snacks) 
• Limited child care subsidies   

Each of these methods have good and bad points. Dependent Care FSAs save on taxes and give more options but can be hard to use and cost more money. Direct payments are more simple and provide help right away, but they are taxed. Providing services directly can cost the employer more money, but they can deduct it. For employees, it's tax-free. Child care business owners should think about their own situation, what employees need, and what the business can do when picking the best way.

Disclaimer 

The information contained here is for educational purposes only and is not intended to constitute legal, tax, or financial advice.