Dependent Care FSAs: What Are They and How Do They Work?

Many employees with children or elders who require daytime supervision have no choice but to pay for expensive dependent care services so they can go to work. Such services can be a significant financial burden to a household budget. A flexible spending account (FSA) earmarked for dependent care, also known as dependent care FSA or DCFSA, is a tool that can shoulder some of these costs and help your employees make their dollars work a little harder.

As an employer, ensuring your employees have reliable dependent care is essential to keeping your business running smoothly. However, the high cost of dependent care services can increase financial anxiety, which in turn, risks impacting productivity and employee wellness. The ability to help your employees find some financial relief while strengthening your workforce reliability is making a DCFSA benefit a popular perk among employers and employees. It's time to learn all about what is dependent FSA so you can communicate essential details to your workers that will help them make the open enrollment benefit choices that maximize their paycheck.

What Is a Dependent Care FSA?

Paying for dependent care services — preschool, before- and after-school programs, child or adult daycare, and summer, winter, or spring day camps — can gobble up a large portion of a paycheck. A dependent care flexible spending account is a pre-tax benefit account used to pay for the various child and adult care programs that allow a caregiver to work.

A DCFSA is also commonly referred to as a childcare FSA, dependent FSA, child FSA, and child dependent care FSA. Regardless of its moniker, this benefit is an important and strategic financial tool that can help your employees go to work knowing their loved ones are being cared for in a trusted environment. In turn, this allows employees to focus on their role at work and remain engaged and productive.

How Does a Dependent Care FSA Work?

It's through the workplace that an employee can use FSA dependent care. How does it work? An employee authorizes a certain amount to be withheld from each paycheck, which is then deposited into an account. To access the funds to pay for eligible dependent care expenses, an employee pays the expense out-of-pocket then requests reimbursement from their employer.

Funds set aside in the dependent care FSA are pretax dollars, which reduces an employee's taxable income. It's important to note that all funds in the account must be used during the plan year and cannot be rolled over to the next.

Healthcare FSA vs. Dependent FSA

While both a healthcare FSA (HFSA) and DCFSA are designed to help ease an employee's financial burden by reducing a participant's taxable income, they each have a slightly different framework. Here are the key differences between a healthcare FSA vs. dependent FSA:

• Eligible expenses. HFSA reimburses eligible out-of-pocket medical expenses. DCFSA reimburses eligible work-related care expenses for qualifying dependents.
• Maximum annual contribution. HFSA: $2,850 for 2022. DCFSA: $5,000 per household ($2,500 for married individuals filing separately) for 2022.
• Rollover and grace periods. HFSA: Up to $570 of unused funds can be added to the following year's plan on top of the contribution limit. If a plan does not offer a rollover or grace period, the participant will forfeit unused funds at the end of the year. DCFSA: Participants must use the money by the end of the plan year and grace period (if it is offered) or forfeit their unused funds.
• Availability of funds. HFSA: Prefunded. Once a participant has determined their annual amount, the full amount of money is available at the start of the plan year. DCFSA: Post-funded. A participant only has access to money in the account as it is contributed throughout the plan year.

Dependent Care FSA vs. Tax Credit

Both the dependent FSA and child and dependent care tax credit provide tax advantages, but they calculate their respective tax breaks differently. The DCFSA usually provides a greater financial gain, especially for those with higher incomes. According to the IRS, the child and dependent care credit is calculated based on the taxpayer's income and percentage of dependent care qualifying expenses. The lower a taxpayer's income, the larger the credit.

The child and dependent care tax credit increased under the American Rescue Plan for the 2021 tax year of up to $4,000 in qualifying dependent care expenses for one eligible child or up to $8,000 for two or more eligible children. The IRS has returned to the previous levels of $2,000 and $4,000 respectively, for the 2022 tax year. This means if an employee's household spends $5,000 or more on qualifying dependent care expenses during the 2022 tax year, they can save $3,000 more than the tax credit if they have one child and $1,000 more with two or more children. It is highly recommended that an employee seeks professional financial advice to determine if participating in the FSA or taking the tax credit is more advantageous to their individual circumstance.

Dependent Care FSA Rules, Requirements, and Limits

There are numerous dependent care FSA rules that specify everything from qualified expenses, what the account can cover, and eligibility. There are dependent care FSA limits on contributions and specifications to what happens to unused funds. It's important your employees understand these various rules, requirements, and limits to determine if a DCFSA is in their best interest and how to make the most of this valuable benefit.

What Can a Dependent Care FSA Be Used For?

What does FSA dependent care cover? It helps your employees pay for services to care for eligible loved ones who cannot fully care for themselves. Think in terms of a child who is too young to stay home alone (typically under the age of 13), or a dependent adult who, due to physical or mental issues, needs care and supervision during an employee's workday.

Dependent Care FSA Eligible Expenses: What Qualifies?

Employees can only be reimbursed through their DCFSA for certain qualified expenses. These are care services that allow them to go to work. Examples of eligible expenses include:

• Daycare, nursery school, or preschool.
• Adult daycare centers.
• After-school programs.
• Babysitting. (Not all babysitting services are eligible. The babysitter cannot be a tax dependent of the employee and the service must be needed to fulfill work or job requirements.)
• Eldercare.
• Extended care such as supervised programs before or after regular school hours.
• Nannies or au pairs.
• Summer day camp.
• Transportation to and from eligible care when provided by your care provider.

There are a number of expenses that might be mistaken for dependent care but are not eligible, according to the IRS. School tuition, tutors, and language class expenses are considered educational expenses, not childcare expenses. Enrichment programs such as hobby-related lessons (music, dance, karate, etc.), sleep-away camps, and field trips are also not eligible. The same goes for food, medical care, nursing home care, and non-work babysitting expenses.

Who Is Eligible for Dependent Care FSA?

Certain dependent care FSA eligibility requirements must be met for an employee to be reimbursed for their out-of-pocket expenses and receive the tax benefit. The recipient of the dependent care service must be a “qualifying individual”, which includes:

• A dependent of the employee who has not reached age 13
• A dependent of the employee who is physically or mentally incapable of caring for themselves and lives with the employee for at least 6 months of the year, or
• The employee’s spouse that is physically or mentally incapable of caring for themselves and lives with the employee for at least 6 months of the year.

The definition of dependent is subject to a number of specific rules regarding that individual’s gross income and tax filing status. Employees should consult with a tax advisor if there are questions regarding qualifying care for a specific individual.

Can You Change Your Dependent Care FSA Mid-Year?

Once an employee finalizes their dependent FSA status and contributions for a plan year, changes are not permitted until the next open enrollment period. However, the IRS does recognize that events like death, adoptions, and marriage don't always conveniently occur during the open enrollment period. An employee can request a change of status during the plan year if they meet any of the following IRS-approved events and the benefit plan permits it. These events are an employee's change of status in:

• Marital status (e.g. divorce, marriage, or death of a spouse).
• Number of dependents (e.g. birth, adoption, or death of a dependent).
• Employment status of the employee, employee's spouse, or dependent.
• Eligibility requirement events (e.g. a dependent becomes eligible or ceases to satisfy an eligibility requirement for the dependent FSA benefit).
• Change of residence for an employee, employee's spouse, or dependent.
• Cost in dependent care coverage.

Dependent Care FSA Contribution Limits for 2022

The IRS sets dependent care FSA contribution limits for each year. For 2022, the IRS caps employee contributions to $5,000 for single filers and couples filing jointly, and $2,500 for married couples filing separately. There are some qualifications to be eligible to take advantage of the full amount.

If a couple is married and filing jointly, both the employee and their spouse must be either working or looking for work. This requirement is waived under one of two conditions: 1) the spouse is disabled (physically or mentally) and lives with the employee a minimum of six months each year, or 2) the spouse is a full-time student. In the event that either an employee or their spouse earns less than $5,000, the IRS caps the contribution limit to the lower of the earned amounts. In the case of a divorced couple, only the parent with whom the child spends the most time can take advantage of the dependent FSA tax break.

How Does an Employee Get Reimbursed From a Dependent Care FSA?

It's important that employees understand exactly how to get reimbursed from FSA dependent care. An employee pays out-of-pocket for a dependent care FSA-eligible expense then completes an employer-provided claim form requesting a reimbursement. Proof of payment for the service in the form of a receipt with specific information must be included with the claim form. The receipt must include:

• The recipient's name (the child or adult receiving the care).
• Service provider's name.
• Date of service.
• Type of service.
• Amount of the expense.

Does Dependent Care FSA Unused Money Rollover?

Dependent care FSA rules are subject to a "use it or lose it" requirement, which means participants must forfeit any unused funds remaining in their account at the end of the plan year and grace period (if a grace period is provided).

If employers find that they have unused funds in their dependent FSA accounts, you have a few options. You can keep the funds as part of the business, use the funds to cover the benefit administrative costs, or opt to have the business return the funds to employees in a reasonable and uniform manner. An employer cannot take the funds as cash or transfer the money to another FSA, such as a healthcare FSA. It's important that employees understand that unused funds at the end of the plan year are subject to forfeiture and are encouraged to assess their annual costs with care.

Benefits of Dependent Care FSA

In addition to alleviating financial strain for your employees, a dependent FSA can help your employees show up for work with peace of mind that their loved ones are being cared for in a safe environment. In a time of uncertainty defined by rapid, dramatic changes, a DCFSA is one benefit that can help your business run smoothly and remain primed for success. Don't miss taking advantage of other FSA benefit account options that can help your workers safeguard the physical, mental, and financial success they deserve.