Big Beautiful Bill permanently enhances dependent care benefits 

The One Big Beautiful Bill Act introduces lasting changes to dependent care benefits, including permanent increases to the annual income exclusion for employer-provided dependent care assistance programs, as well as enhancements to the child and dependent care tax credit and the employer-provided childcare tax credit, beginning in 2026.

Increased dependent care assistance programs annual income exclusion.

Starting in 2026, OBBBA permanently raises the annual income exclusion for dependent care assistance programs, which includes employee pretax contributions to dependent care flexible spending arrangements and employer-subsidized childcare expenses, such as onsite day care centers. The exclusion amount will increase from $5,000 to $7,500, and from $2,500 to $3,750 for married couples filing separately. These amounts are not indexed for inflation.

Enhanced child and dependent care tax credit. Starting in 2026, OBBBA also permanently expands the dependent care tax credit (non-refundable), making it more beneficial for qualifying taxpayers. The maximum applicable percentage of dependent care expenses increases from 35% to 50%, providing greater savings. The dependent care tax credit begins to phase down gradually from 50% for individuals with Adjusted Gross Income exceeding $15,000, to 35% for those with AGI of $43,001 to $75,000. It further phases down from 35% to 20% for those with an AGI exceeding $75,000 ($150,000 for joint filers). The credit plateaus at 20% for those with an AGI exceeding $103,000 ($206,000 for joint filers). The maximum eligible dependent care expenses remain unchanged at $3,000 for one qualifying individual and $6,000 for two or more qualifying individuals.

Enhanced employer-provided childcare tax credit. Starting in 2026, OBBBA increases the maximum employer-provided childcare tax credit (non-refundable) from $150,000 to $500,000 (indexed for inflation), and the percentage of “qualified childcare expenditures” covered from 25% to 40% ($600,000 and 50% for eligible small businesses). This tax credit is an incentive for employers to provide childcare services — such as onsite day care — to their employees.

Employer considerations. Employers should be mindful of nondiscrimination testing for dependent care FSAs, as more employees may choose to claim the dependent care tax credit instead of participating in the dependent care FSA, which could impact testing outcomes. While, on its face, this dependent care assistance program enhancement may appear to benefit employees currently contributing the maximum $5,000 to a dependent care FSA who wants to contribute more, many of these employees may be classified as Highly Compensated Employees. For employers that have historically struggled to pass the 55% average benefits nondiscrimination test for dependent care assistance programs, adopting this increased limit could make compliance more challenging, since higher contributions are often made by HCEs. This test requires that the average benefits provided to non-HCEs be at least 55% of the average benefits provided to HCEs — for 2026 testing, generally, employees earning over $160,000 in 2025 — across all dependent care assistance programs of the employer. If the test is not met, all benefits actually paid to or received by HCEs would be taxable.

Additionally, the enhanced dependent care tax credit may incentivize more non-HCEs to claim the dependent care tax credit instead of participating in the employer’s dependent care FSA, further complicating efforts to meet the 55% average benefits test.

When contemplating whether to raise the dependent care FSA limit for the 2026 plan year and beyond, employers should evaluate:

• Would increasing the dependent care FSA limit help employees, and particularly non-HCEs, who currently participate? According to Mercer’s 2023 National Survey of Employer Sponsored Health Plans, only 5% of eligible employees participated in a dependent care FSA, with an average contribution of $3,220.
• Would increasing the dependent care FSA limit for all employees increase the plan’s risk of failing nondiscrimination tests, particularly the 55% average benefits test?

Employers considering an increase should amend their plan documents before the beginning of the 2026 plan year — January 1, 2026, for calendar-year plans — and communicate the new limits during open enrollment. While employers should not advise employees on whether a dependent care FSA or the dependent care tax credit is more advantageous, they may choose to inform employees about the expanded options available in 2026 and beyond and recommend consulting with a tax advisor to review individual circumstances.