PACE Act Proposes Bigger Childcare Tax Breaks: Credit Boosted to 50%, Employer Benefit Exclusion Rises to $7,500 Starting 2026

The Promoting Affordable Childcare for Everyone Act, or PACE Act, aims to ease the financial pressure of childcare for working families by enhancing key tax benefits. This legislation directly amends the Internal Revenue Code to increase the value of the Child and Dependent Care Tax Credit (CDCTC) and raise the amount employees can exclude from income for employer-provided dependent care assistance. These changes are slated to take effect for tax years beginning after December 31, 2025.

Your Tax Credit Gets an Upgrade: More Cash for Childcare

Currently, families can claim a non-refundable tax credit for a portion of their childcare expenses. The PACE Act significantly revamps this benefit in a few ways. First, Section 3 boosts the maximum credit rate from 35% to 50% of eligible expenses. This means families could potentially claim a larger credit for the same amount spent on care.

Crucially, Section 2 makes the credit refundable. This is a big shift. Right now, the credit can only reduce the amount of tax you owe down to zero. A refundable credit means that even if you owe no income tax, you could still receive the credit amount back as part of your tax refund. This change, which involves redesignating the credit from Section 21 to Section 36C of the tax code, could particularly benefit lower-income working families.

Additionally, the bill acknowledges that costs rise. Section 3 mandates that the dollar limits for eligible expenses used to calculate the credit will be adjusted for inflation annually starting in 2026, using 2024 as the base year. This helps ensure the credit's value doesn't erode over time.

Using Work Perks: Bigger Pre-Tax Savings for Dependent Care

Many employers offer Dependent Care Assistance Programs (DCAPs), often through Flexible Spending Accounts (FSAs), allowing employees to set aside pre-tax dollars for childcare. Section 4 of the PACE Act increases the maximum amount an employee can exclude from their gross income through these programs. The annual limit jumps from $5,000 to $7,500 (or half that amount for those married filing separately).

Putting more money into a DCAP pre-tax lowers your overall taxable income, resulting in tax savings. For someone paying significant childcare costs, this increased $7,500 limit means potentially larger tax savings each year. Like the CDCTC, this $7,500 exclusion limit will also be adjusted for inflation annually, beginning after 2026 (using 2025 as the base year), as outlined in Section 4.

When Does This Kick In? The Nuts and Bolts

It's important to note the timeline. All the major changes introduced by the PACE Act – the increased credit percentage, refundability, the higher employer exclusion limit, and the start of inflation adjustments – apply to taxable years beginning after December 31, 2025. In practical terms, this means these changes would first impact the tax return you file in early 2027 for the 2026 tax year.

The bill also includes technical updates (Section 2) to ensure references to the Child and Dependent Care Tax Credit are accurate throughout the tax code, reflecting its move to Section 36C. While these are mostly administrative, they are necessary for the tax system to function correctly with the new changes. The core takeaway is a potential increase in financial support for childcare costs through the tax system starting in 2026.