How to Reduce Employee’s Child Care Costs

can significantly enhance employee satisfaction and retention. For child care business owners, providing free child care to their own employees is not just a perk, but a powerful statement of support and understanding of their needs.

Why cover child care costs?

Employer-provided child care support offers multiple benefits. Firstly, it provides financial relief for families, reducing the burden of child care expenses and allowing parents to allocate resources to other essential needs. 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.

How can I reduce the cost of child care?

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. You can learn more about this credit in this guide.

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: