U.S. Economic Growth and Tax Reconciliation Act of 2001

The new law provides taxpayers a credit equal to 25% of the qualified expenses for employee child care and 10% of qualified expenses for child care resource and referral services. The maximum total credit that may be claimed by a taxpayer cannot exceed $150,000 per taxable year. Qualified child care expenses include costs paid or incurred:

• To acquire, construct, rehabilitate or expand property that is to be used as part of the taxpayer's qualified child care facility;

• For the operation of the taxpayer's qualified child care facility, including the costs of training and certain compensation for employees of the child care facility, and scholarship programs; or
• Under a contract with a qualified child care facility to provide child care services to employees of the taxpayer.

To be a qualified child care facility, the principal use of the facility must be for child care (unless it is the principal residence of the taxpayer), and the facility must meet all applicable state and local laws and regulations, including any licensing laws. A facility is not treated as a qualified child care facility with respect to the taxpayer unless:

• It has open enrollment to the employees of the taxpayer;
• Use of the facility (or eligibility to use such facility) does not discriminate in favor of highly compensated employees of the taxpayer (within the meaning of Sec. 414(q)); and
• At least 30% of the children enrolled in the center are dependents of the taxpayer's employees, if the facility is the principal trade or business of the taxpayer.

Qualified child care resource and referral expenses are amounts paid or incurred under a contract to provide child care resource and referral services to the employees of the taxpayer. Qualified child care services and qualified child care resource and referral expenditures must be provided (or be eligible for use) in a way that does not discriminate in favor of highly compensated employees.

Any amounts for which the taxpayer may otherwise claim a tax deduction are reduced by the amount of these credits. Similarly, if the credits are taken for expenses of acquiring, constructing, rehabilitating, or expanding a facility, the taxpayer's basis in the facility is reduced by the amount of the credits. Credits taken for the expenses of acquiring, constructing, rehabilitating, or expanding a qualified facility are subject to recapture for the first 10 years after the facility is placed in service. The amount of the recapture is reduced as a percentage of the applicable credit over the 10-year period. Recapture takes effect if the taxpayer either ceases operation of the facility or transfers its interest in the facility without securing an agreement to assume recapture liability for the transferee. Example--

Madison Inc. constructs a child care facility in the lot adjoining the company's offices. The cost of constructing the facility is $400,000. The facility is completed in 2002. In addition, the qualifying operations costs for the first year are $90,000. Madison can claim a credit of $100,000 with respect to the construction costs (25% of $400,000). The credit of $100,000 reduces Madison's cost basis (for depreciation and other purposes) in the facility to $300,000 ($400,000 less $100,000). In addition, Madison can take a credit of $22,500 (25% of $90,000) for the cost of operating the facility in 2002. However, Madison must reduce the expenses by the amount of the credit to calculate the company's deductible expenses. Thus, it can only deduct $67,500 ($90,000 less $22,500) of the cost.

Tax Tip--

There have been other provisions in the law in past years encouraging child-care facilities, but this is clearly the most generous. If the business considerations (number of employees who can take advantage of the facilities, cost structure of your business, etc.) come even close to justifying the expense, this credit could easily make the project economically viable.

This provision is effective for tax years beginning after December 31, 2001. These credits are subject to recapture for the first ten years, the amount of recapture is reduced as a percentage of the credit over the 10-year period. Recapture takes effect if you either cease operation of the qualified facility or you transfer your interest in the facility without securing an agreement to assume recapture liability for the transferee.