Posted on: July 17, 2024                                                                                                  

Balancing work and caring for a child or an ill family member can be challenging. Employees may need to call out of work unexpectedly or exhaust all their paid time off to care for a loved one. Employers that offer dependent care flexible spending account (FSA) benefits may help alleviate some caretaker stress for employees and can help improve their productivity, engagement and retention.

What is a dependent care FSA?

A dependent care FSA, also known as a dependent care assistance plan (DCAP), is an employer-sponsored benefit that helps working employees manage their expenses associated with caring for a qualified dependent, such as a child or incapacitated family member.

Why offer a dependent care FSA?

Employers who offer FSAs may be able to:

• Improve productivity and engagement;
• Attract and retain talent; or
• Reduce stress and workplace disruptions.

Employers can also contribute to an employee’s dependent care FSA if the employer’s plan allows it, so long as the combined pretax contributions between the employer and employee do not exceed the IRS annual maximum.

What does a dependent care FSA cover?

Covered dependent care FSA reimbursements generally must make it possible for an individual and their spouse (if married) to work, seek employment or attend school full-time.   

How do dependent care FSA benefits work?

Employees who enroll in a dependent care FSA contribute a portion of their compensation to help cover the cost of dependent care services. Their employer then deducts these contributions via pretax payroll deductions.

As employees incur qualified dependent care expenses, they generally pay them out of pocket and then apply for reimbursement from the FSA. Some participants may also receive a spending account card, which works like a bank debit card and provides immediate reimbursement.

Contributions

Under federal law, an employee is limited to contributing the smallest of the following amounts to their dependent care FSA:

• $5,000 (if the employee is married and filing a joint return or is a single parent);
• $2,500 (if the employee is married but filing separately);
• The employee's earned income for the year; or
• The spouse's earned income (if the employee is married at the end of the taxable year).

Employers can also set a limit lower than the amounts listed, but not in excess. 

Note: Contributions to a dependent care FSA that exceed the imposed limit during a calendar year are treated as taxable income.

After selecting a contribution amount, the only time an employee can change their contribution during the remainder of the year is for a qualifying event, such as a change in marital status, employment status or the number of dependents.

Funds

Dependent care FSA funds are used up throughout the year. Generally, any funds that remain in the account at the claim filing deadline for the year is forfeited. However, employers may allow participants to use outstanding year-end balances to reimburse expenses for qualified dependent care benefits incurred during a grace period of up to two months and 15 days following the close of the plan year.

Covered individuals

To participate in a dependent care FSA, an employee’s dependent must be:

• Less than 13 years of age; or
• A spouse (or qualifying child or relative) who cannot physically or mentally care for themselves and has lived with the employee for more than half the year.

Note: The other individual must also be a dependent of the employee or would have been a dependent if not for certain exclusions.

Dependent Care FSA tax information

Are dependent care FSA benefits taxable?

Contributions to a dependent care FSA that do not exceed the IRS limit can reduce an employee’s taxable income. Contributions that surpass the annual maximum are subject to the required taxes.

Tax credits information

Employees whose employers choose not to offer a dependent care FSA can help manage their dependent care costs with the child and dependent care tax credit. This credit offsets a percentage of work-related expenses paid to a childcare provider for the well-being and security of a qualified dependent. The qualifications are also the same as those for a dependent care FSA.

Child and dependent care tax credit thresholds

Depending on individual circumstances, the child and dependent care tax credit may be more beneficial than enrolling in a dependent care FSA. However, individuals may not claim the tax credit for childcare expenses reimbursed under a dependent care FSA.

The total credit available depends on the employee’s adjusted gross income and the number of qualified dependents. The maximum tax credit limit is:

• $3,000 for employees with one qualifying person; or
• $6,000 for employees with two or more qualifying people.

Can an individual claim the child tax credit and dependent care credit?

An individual may claim the child tax credit and the child and dependent care tax credit if they meet all the qualifying criteria and file the necessary forms. However:

• They may not claim the child and dependent care tax credit for childcare expenses reimbursed under a dependent care FSA; and
• The amount contributed to the dependent care FSA and claimed under the dependent care tax credit cannot exceed the applicable IRS limit.

To find the allowed dependent care tax credit base amount, subtract the contributions to a dependent care FSA from the dependent care tax credit maximum.

Who is responsible for managing use of a dependent care FSA?

Generally, the plan sponsor owns and manages dependent care FSAs. If an employee separates from their employer or doesn’t use all of their funds by year’s end, they forfeit the remainder of the money and it is retained by the plan sponsor. 

Note: Employers may permit employees who no longer participate in a dependent care FSA (e.g., due to termination of employment) to be reimbursed from their outstanding account balances for eligible expenses incurred during the remainder of the plan year.

Conclusion

A dependent care FSA can help working employees manage their expenses associated with caring for a qualified dependent, such as a child or incapacitated family member, and may help employers who offer them to decrease unplanned absenteeism, improve productivity and engagement, attract and retain talent, or reduce stress and workplace disruptions.