Dependent Care Benefits for Owners: The Five-Percent Concentration Test Can Bind First

A larger ceiling does not guarantee an owner exclusion

A dependent care assistance program must satisfy qualification and nondiscrimination requirements before an owner can exclude benefits. For 2026, the general annual exclusion ceiling rises to $7,500, or $3,750 for married filing separately. However, no more than 25% of the amounts paid or incurred under a qualifying program may be provided to people who own more than 5% of the employer, including the applicable spouses and dependents. A program designed almost entirely around the founder’s childcare can therefore fail despite staying below the individual dollar ceiling.

The practical decision is to run the employee and ownership tests before promising a pretax owner benefit. The owner-concentration rule is distinct from the more-than-2% S corporation rules that apply to certain other fringe benefits. Do not copy eligibility conclusions across benefit categories. Dependent care also has earned-income and qualifying-care requirements at the household level, so a passing employer program does not automatically make every claimed expense excludable.

Measure the concentration in actual dollars

Assume a program pays $7,000 for a more-than-5% founder and $13,000 for all other participants. The founder-related share is $7,000 divided by $20,000, or 35%. That exceeds the 25% concentration ceiling. If all else remains equal, total qualifying program benefits would need to reach $28,000 for $7,000 to represent 25%, meaning $21,000 for other participants. This arithmetic illustrates the test; it does not authorize inventing employee expenses or contributions to manufacture compliance.

Alternatively, if the nonowner benefits remain $13,000, the owner amount satisfying a 25% ratio solves owner benefits divided by owner benefits plus $13,000 equals 0.25. That produces approximately $4,333.33. Actual program testing and correction rules must determine the final excludable treatment. The important point is that increasing the statutory individual cap to $7,500 does not erase an independently binding concentration limit, and the nominal election amount is not always the same as the amount tested.

Collect household and program evidence separately

Employer records should establish plan terms, eligibility, enrollment, participant ownership, reimbursements, and testing results. Participant records should establish qualifying care, service dates, provider information, and the relationship to work. A payment for school tuition is not automatically dependent care, and expenses already reimbursed elsewhere should not be claimed again. Distinguish the dependent care program from any employer childcare-facility credit, which involves different employer requirements and does not answer the owner’s wage-exclusion question.

The household must coordinate excluded employer benefits with the dependent care credit. The same expense cannot support both benefits without the required reduction and limitations. Spouse earned income, student status, disability rules, and filing status can affect the available exclusion. Ask for the minimum data needed to establish those conditions through the administrator’s secure process. A bank transfer to a childcare provider establishes payment but does not establish the full program or household tax result.

A salary-reduction election and an employer-funded reimbursement both enter a program requiring qualification review; calling the payment employee money does not remove the concentration concern. Obtain the testing methodology from the administrator and compare it with actual participant data. If an employee leaves during the year, understand how elections, reimbursements, and remaining claims affect the tested amounts. That operational change can alter the founder’s expected treatment without any change in the founder’s own childcare spending.

Approve benefits using a tested forecast

At enrollment, forecast likely participant use and identify the more-than-5% owner group. Revisit the forecast if employee participation falls or reimbursements differ materially from elections. A founder whose expenses are predictable may become a larger share of actual program spending when employee claims are lower than expected. Plan administration should monitor that risk before the year closes, rather than learning it only when payroll information returns are being prepared.

The approval should state the benefit budget, testing assumptions, employee communication, and process for taxable amounts. Form W-2 reporting for dependent care has its own requirements, including reporting benefits even when an exclusion is available. Reconcile the plan report with payroll rather than assuming an excluded benefit disappears from all reporting. The result should tell the owner how much childcare support the company will provide, what portion can be excluded under the actual facts, and which amounts remain part of the household’s separate tax calculation.