COVID-19 Relief Bills Offer Dependent Care FSA Flexibility
Sam Slade, Business Contribibutor
COVID-19 Relief Bills Offer Dependent Care FSA Flexibility
Changes Under the Consolidated Appropriations Act
The Consolidated Appropriations Act, which was signed on December 27, 2020, added a few optional special rules for dependent care FSAs (DCFSA), including permitting employers to:
• Carryover unused amounts from the 2020 plan year to the 2021 plan year, and from the 2021 plan year to the 2022 plan year;
• Extend the grace period for plan years ending in 2020 and/or 2021 to 12 months after the end of the plan year (previously this was only 2 ½ months); and/or
• Allow prospective election changes without regard to a change in status for plan years ending in 2021.
Changes Under the American Rescue Plan Act
The American Rescue Plan Act (ARPA) temporarily increases the maximum dependent care FSA contribution from $5,000 to $10,500 (from $2,500 to $5,250 for married individuals filing separately) for the 2021 tax year. The change to temporarily increase the maximum allowed contribution is not mandatory, allowing employers to determine whether to permit the higher limits. It appears that any discretionary carryover allowed under the CAA for dependent care FSAs would not be included in the maximum dollar limit for 2021.
Plans may be amended retroactively for the change, as long as the amendment is adopted by the last day of the plan year in which the amendment is effective (e.g., December 31, 2021 for calendar year plans) and the plan is operated in accordance with the amendment’s terms beginning on its effective date.
ARPA also made several modifications to the child and dependent care credit. Like the changes to dependent care FSAs, changes to the child and dependent care credit are effective for tax year 2021 only. ARPA raises the dollar limit on employment-related child and dependent care expenses from $3,000 to $8,000 for one qualifying child and from $6,000 to $16,000 for two or more qualifying children. In addition, the maximum reimbursement percentage is increased from 35% to 50%. Consequently, the maximum allowable credit has been increased to $4,000 for one child and $8,000 for two or more children.
The percentage phases down for taxpayers earning between $125,000 and $400,000 in gross income.
The tax benefits available under a DC FSA and the child and dependent care tax credit can be combined, but not used for the same expense. The decision whether to contribute to a DC FSA and/or claim the child and dependent care tax credit is a personal tax matter that employees should discuss with their tax advisor.
Employer Considerations
There are a number of issues an employer may consider when deciding whether to adopt any of the CAA provisions or the increased ARPA contribution limit.
Although ARPA increases the annual contribution limit, employers may want to consider whether they wish to take advantage of the CAA provision permitting prospective mid-year election changes; otherwise, only those employees who have a mid-year status change event would be able to take advantage of the increased contribution limit.
Employers may wish to review their DC FSA plan to determine if the plan includes a dollar amount for the annual contribution limit, or whether the plan refers to Internal Revenue Code Section 129, which may result in the plan automatically adopting the increased annual limit.
If the employer is considering adopting both the carryover provisions of the CAA for 2020 and 2021 plan years, as well as the increased ARPA limit, it could result in some employees having very large DC FSA balances in 2022. For example, if an employee carries over $5,000 from 2020 to 2021, contributes $10,500 in 2021 and has no expenses, and then carries over the full $15,500 to 2022 and contributes another $5,000 in 2022 (when the limit is supposed to return to its normal amount), the employee could end up with an account balance of $20,500 in 2022.
Sam Slade is Managing Director, Employee Benefits, at The Hilb Group of New England, where he delivers consulting and brokerage services to local employers. He has extensive experience in all aspects of employee benefits, including underwriting, plan design, communications, compliance, and analytics, with a particular focus on alternative funding and self-insurance. Sam lives in South Kingstown with his wife and three sons.
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