A dependent care flexible spending account (FSA) allows your employees to save for qualified dependent care expenses. This can make supporting a family or caring for a spouse or dependent less expensive.
That’s because dependent care FSAs are funded through pre-tax payroll deductions, which offer two major benefits and tax implications:
- Contributing to a dependent care FSA lowers your employee’s taxable income, and that decreases their tax burden—so they owe less come tax time.
- Because this money isn’t taxed, they’re saving about 30% on qualified expenses.
Setting up a dependent care FSA at your company helps your employees get the most out of their paycheck—and can help promote your company’s work-life benefits.
What can a dependent care FSA be used for?
A dependent care FSA helps shoulder some of the costs of childcare or adult care services.
Generally, this includes expenses involved in caring for either a child under the age of 13 (or 14, depending on your plan) or a physically or mentally incapacitated spouse during the workday.
It can also help your employees care for other eligible loved ones who aren’t physically or mentally able to take care of themselves.
To be eligible, that person must live with your employee for at least six months of the year and be your employee’s tax dependent. They can also qualify if they live with your employee for at least half the year and are not your employee’s tax dependent because of one of the following reasons:
- They had a gross annual income of $4,300 or more,
- They filed a joint tax return, or
- Your employee was someone else’s dependent.
What are qualified dependent care expenses?
Qualified expenses include:
- Adult day care centers
- After school programs
- Babysitting—as long as the babysitter is not a tax dependent, and the babysitting is needed due to work or job requirements
- Elder care
- Extended care (supervised program before or after regular school hours)
- Nannies or au pairs
- Nursery school or preschool
- Summer day camp
- Registration fees (required for eligible care, after actual services are received)
- Transportation to and from eligible care (provided by your care provider)
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But not all dependent care costs can be reimbursed. Any expense that isn’t directly related to your employee’s job duties is likely to be non-reimbursable.
Here are some examples of ineligible expenses:
- Educational services, such as a tutor
- Field trips
- Hobby-related lessons, like piano or dance
- Kindergarten or school tuition
- Language classes
- Medical care
- Non-work-related babysitting—for example, if your employee and their spouse would like to go to a movie
- Nursing home care
- Sleep-away camp
The full list of dependent care FSA eligible expenses is lengthy—refer your employees to the federal government’s official list.
Note: It is important that participants save their receipts and other supporting documentation related to their DCFSA expenses and claims since the IRS may request itemized receipts to verify the eligibility of the expenses.
What are the dependent care FSA contribution limits?
The IRS caps how much money your employees can contribute to their dependent care FSA.
The annual contribution limit for a dependent care FSA is:
- $2,500 if your employee is married and filing their taxes separately, or
- $5,000 if your employee and their spouse are filing jointly, or if they’re filing taxes as a single person or as the head of household.
If your employee is married, the IRS requires both them and their spouse to have earned income to qualify for a dependent care FSA. This means that both of them must be working or looking for work. The IRS waives this requirement if your employee’s spouse was a full-time student or was either mentally or physically disabled and lived with your employee for at least half the year.
And if either spouse earns less than $5,000 during the year, the IRS cap is lowered. In such a situation, the dependent care FSA limit becomes equal to the smallest earned amount.
For example, if your employee’s husband only made $3,500 in earned income, the couple can only contribute a maximum of $3,500 to their dependent care FSA (assuming they are married filing jointly).
One more head’s up: divorced parents who share custody cannot both seek reimbursement for childcare expenses.
Only the custodial parent—in this case, the one with whom the child spends more nights—can take advantage of a dependent care FSA. That’s true even if the other parent claims the child as a dependent on their taxes.
Once your employee chooses how much they want to contribute each year, they’re not allowed to change the amount until the next plan year—unless they experience a qualifying life event such as getting married or divorced or having a baby.
Table: Dependent Care FSAs versus Health FSAs at a glance:
|Detail||Health FSA||Dependent Care FSA|
|Enrollment Eligibility||Employer must offer as a benefit||Employer must offer as a benefit|
|Eligible Expenses||IRS eligible out-of-pocket medical expenses||IRS eligible work-related care expenses for qualifying dependents|
|Max annual contribution (2021)||$2,750||$5,000 ($2,500 for married individuals filing separately) For 2021 in relation to COVID-19, if allowed by administrator: up to $10,500.|
|Who Contributes||Employees and Employers||Employees and Employers|
|Who Owns the Money||Employer||Employer|
|Runout||Set by employer (typically up to 90 days after the end of the plan year)||Set by employer (typically up to 90 days after the end of the plan year)|
|Rollover & Grace Periods||A maximum rollover of $550 in unused funds can be added to the following year’s plan on top of the contribution limit. There is a 2.5 month grace period to use unused money or expenses. If the plan does not offer a rollover or grace period, it is “use-it-or-lose-it.”||“Use-it-or-lose-it.” Participants must use the money in the account by the end of the year or they lose it.|
|Money Availability||At the beginning of the plan year once the participant has determined their annual contribution amount. The full amount of money is available even if the participant has not yet contributed to the account. This is called “pre-funded.”||The money becomes available as the participant contributes to the account. Thus, the participant only has access to the amount of money actively in their account. This is called “post-funded.”|
What are the rules for dependent care FSAs?
Similar to health FSAs, there’s a “use or lose” rule on these dependent care flexible spending accounts. That means your employees forfeit any funds remaining in their account when the plan year ends.
So your employees should make sure to carefully consider how much they want to contribute each year and then spend and apply for reimbursements promptly.
Some benefits providers may allow you to set up a 2.5-month grace period for employees, which allows extra time to use up remaining benefits after the plan year ends.
You can also allow up to $500 of your employee’s dependent care FSA balance to be transferred into the next year’s plan. That’s called a rollover.
It is important to note that unlike health care FSAs, where participants can access the entire amount they plan to contribute for the year on January 1st, participants can only use money from the dependent care FSA account after they make the contributions from their paychecks.
What do I do with employees’ unused funds?
Because the dependent care FSA is a “use it or lose it” plan, your company may find itself left with employee’s unused plan balances.
The IRS offers a few options for handling these excess funds. You can:
- Keep them as part of the company’s funds
- Use the money to help cover the administrative costs of offering a dependent care FSA plan
- Return the funds to your employees on a “reasonable and uniform basis.” That means you can’t decide to allocate different amounts of money to individual employees based on how many claims they made.
Have there been updates to Dependent Care FSAs since COVID-19?
Yes! The Coronavirus Aid, Relief, and Economic Security (CARES) Act and recent IRS guidance have added more flexibility to health FSA and DCFSA plans.
Some new rules include:
- New opportunity to increase, decrease, start or stop your FSA elections.
- More flexibility to change dependent care contributions.
A quick note about COVID-19: While the 2020 COVID relief bill granted temporary, optional exceptions and changes to DCFSAs in 2021 and 2022, Gusto is currently not supporting the following amendments.
- Employers can extend the grace period to 12 months after the end of the plan year for the 2021 plan year.
- The American Rescue Plan Act of 2021 increased the annual DCFSA contribution limit from $5,000 ($2,500 for married individuals filing separately) to $10,500 ($5,250 for married individuals filing separately)