3517 / What is a dependent care flexible spending arrangement?

Editor’s Note: The American Rescue Plan Act (ARPA) allowed employers to increase contribution limits for dependent care assistance programs (DCAPs) or dependent care FSAs to $10,500 for 2021. The 2021 CAA also allowed participants to carry over unused DCAP benefits from 2020 or 2021 into the following plan year. Initially, there was some confusion over the tax consequences if a participant took advantage of both the increased contribution limit and carryover relief. Notice 2021-26 clarified the issue by providing that participants could take advantage of both (1) tax-free reimbursements of contributions made during the 2021 plan year up to the maximum $10,500 limit and (2) tax-free reimbursements of amounts carried over from the prior year. In other words, a participant with a $5,000 carryover amount from 2020 and a $10,500 contribution in 2021 could take tax-free distributions up to $15,500 in 2021 if that participant incurred enough qualifying expenses during the 2021 plan year.

Substantially the same rules apply to dependent care FSAs as health FSAs, except that the maximum amount of reimbursement need not be available throughout the period of coverage. A plan may limit a participant’s reimbursement to amounts actually contributed to the plan and still available in the participant’s account.¹ Contributions to a dependent care FSA may not exceed $5,000 during a taxable year.²

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Planning Point: With so many employees working from home in 2020 and 2021, many employees began rethinking contributions to dependent care FSAs. The rules governing changes to dependent care FSA contributions are more flexible than health FSAs. Employees are permitted to make mid-year changes in pre-tax contributions if their circumstances relating to the need for dependent care changes. Employees can reduce their contributions if they are working from home and do not need childcare, or they can increase the contributions when they return to work and need to provide for increased childcare costs.

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Further, employees who were furloughed or laid off might have asked whether their plan contains a spend-down feature. These features are optional but allow former employees to seek reimbursement for dependent care expenses incurred through the end of the tax year (even if their employment was terminated). Employers have the option of adding a spend-down feature at any time.

Like a health FSA, a dependent care FSA may permit a grace period of no more than 2½ months following the end of the plan year for participants to incur and submit expenses for reimbursement.³ The $500 carryover rule applicable for health FSAs after 2013, however, is not available for participants in a dependent care FSA.

The IRS has also approved the use of employer-issued debit and credit cards to reimburse for recurring dependent care expenses. Because expenses may not be reimbursed until the dependent care services are provided, reimbursements through debit cards must flow in arrears of expenses incurred.⁴