DCAP — Use it or Lose It

Employers who are interested in implementing a Dependent Care Assistance Plan (DCAP) or adopting additional flexibility should consult legal counsel, as well as the Internal Revenue Service’s (IRS) Notice 2021-26.

The notice clarifies what amounts may be reimbursed under a DCAP on a tax-favored basis for 2022.

A DCAP functions much like a health flexible spending account and allows an employer or employee to contribute funds to an account that can be used to reimburse dependent care expenses on a tax-favored basis. Employee contributions to DCAPs are made through the employer’s Section 125 cafeteria plan. Common eligible expenses include a nursery school, preschool or similar program below the kindergarten level; before- or after-school care; child-care centers; day camps; and in some cases, babysitters. Employees must decide, at the beginning of the coverage period, what they are going to contribute over the duration of the coverage period (plan year).

Regardless of who makes the contributions, the annual contribution amount in 2022 is limited to the lesser of:

• $5,000 for single individuals or married individuals filing joint tax returns ($2,500 for married individuals filing separately)
• The earned income of the employee/ spouse

This amount is lower than the $10,500 that was allowed in 2021.

Income put into a DCAP must be used or forfeited. However, plans may allow a two-and-a-half-month grace period during which employees can still incur expenses and submit claims to the DCAP. Employees who have money left over at the end of the plan year, including the grace period, must state as taxable income any amount reimbursed above $5,000 during the calendar year.

Employers should report DCAP contributions in Box 10 on employees’ Forms W-2.