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Dependent care FSAs: What’s eligible, what’s not and some surprising benefits

Benefits Administration and Outsourcing Solutions
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By Kim Tippens | December 8, 2020

Understanding important details about dependent care FSAs can help your employees save money and plan for expenses.

As a New Year looms ahead and the pandemic certain to continue into 2021, now is a good time to communicate to your employees the advantages of dependent care flexible spending accounts (FSAs).

For those unfamiliar, dependent care FSAs allow your employees to use pre-tax contributions to pay for expenses related to the care of their dependents. Especially now, during the pandemic, many families with younger dependents are experiencing and exploring care in different ways.

Even for those who are familiar with dependent care FSAs, there are a great deal of intricacies regarding what is and is not covered and how or when it is covered. In this blog, we answer those questions and offer some helpful tips for making the most of a dependent care FSA.

Who’s eligible

Dependent care expenses can only be reimbursed for qualifying persons. Before we explore the expenses that are eligible for reimbursement from a dependent care FSA, let’s first start with understanding who is a qualifying person:

  • A child under the age of 13 at the time the care was provided and who lives with the employee for at least half of the year
  • Other relatives, such as a spouse, adult children, parents and extended family, who are physically or mentally unable to care for themselves, reside with the employee for the entire year, depend on the employee for at least 50% of their support, and whom the employee is able to claim as dependents on his or her tax return

The list of criteria for qualifying dependents is not exhaustive, and there may be other requirements affecting the eligibility of those other than an employee’s natural children. When in doubt, employees should consult with a tax advisor or reference IRS Publications 501.

What’s eligible

Now that we know who can be considered a qualifying dependent, let’s take a look at eligible expenses.

The most common use of dependent care FSAs are day care expenses, such as childcare centers, care at home, and before and after school care.

Additionally, less well-known categories that may also be eligible for coverage using dependent care FSA funds include care of a spouse or adult dependent with a disability. Here are a few more categories of care that qualify as eligible expenses:

  • Day camps: Participants should think about expenses over the summer or seasonal periods (e.g., holiday break or spring break) when their day care provider or school may not be available and set aside funds for these days as well. However, make sure employees understand that deposits for camps are eligible for reimbursement only after the camp has started. For example, a $250 deposit paid February 15 for a camp starting on June 1 is not eligible to be reimbursed until on or after
    June 1.
  • Elder care: Custodial (non-nursing) care received in the employee's home or an adult day care facility may be eligible. Other expenses include senior care, care at someone else’s home, and transportation to and from the location of the person or agency providing the care.
  • Babysitting that is work-related: Care provided by a neighbor, family member or someone else who is not a tax dependent is eligible. It is important to note that the participant may not be responsible for withholding payroll taxes for these self-employed individuals; however, these individuals must include the income received if or when they file income taxes.
  • Transportation: If a care provider takes a qualifying person to or from a place where dependent care is provided, those expenses may be eligible for reimbursement.
  • Household services: The expenses of a household employee who also provides care for a qualifying dependent may be eligible for reimbursement. Household employees may include housekeepers, cooks and maids. It’s important for your employees to check their claim administrator’s eligible expense list and documentation requirements, as some household employees may be excluded, or your employee may be required to provide additional documentation or itemized expenses to demonstrate that the expenses are directly related to the care of qualifying dependent(s).
  • Fees and deposits: Deposits, registration fees and application fees required to obtain care are eligible. Common examples include deposits required to reserve a place for a child at a day care center or preschool, nanny or au pair application fees and deposits required for day camps. However, these fees are eligible only after care has started.
  • Taxes paid on wages: The taxes participants pay to a household employee who provides care to qualifying dependents are considered to be work-related and eligible for reimbursement. Participants should check with their employer’s claim administrator for specific documentation requirements.
  • Sick childcare/backup childcare: There are times when children cannot go to their day care provider or school due to illness. The fees associated with sending a child to a sick-child facility or a backup care provider are eligible.

What isn't eligible?

Just as it’s important to know which expenses are eligible when employees are planning their contributions to a dependent care FSA, it’s also important to know exactly which expenses are not eligible. Participants cannot use dependent care FSA funds for the following services:

  • Overnight camps: This is often an area of confusion. The IRS does not consider overnight camps to be work-related; therefore, the entire expense is ineligible.
  • Activity fees: These typically include field trip fees, arts and crafts fees, fees for supplies, and fees for personal enrichment activities such as dance and piano lessons.
  • Online/virtual day camps: This has become more popular since the onset of COVID-19. While virtual day camps may entertain or engage dependents in activities, they are not providing care of the dependent.
  • Tutors: Tutors provide educational assistance, which is not considered primary care of the dependent.
  • Babysitting for an evening out: While the intent may be for the care of the dependent, the primary need is not work-related.
  • School tuition: Only preschool tuition is eligible.

10 tips to help your employees use dependent care FSAs

  1. 01

    Communicate tax savings to your employees. Many will incur dependent care expenses and should understand the advantages of enrolling in a dependent care FSA (this video is a great tool for helping explain what a dependent care FSA is to employees). Any amount contributed via payroll deduction is exempt from taxes. For example, a $5,000 contribution for those falling in the 32% tax bracket could result in a savings of almost $1,600, including both federal income tax and the 7.65% Social Security and Medicare tax.

  2. 02

    If you offer a subsidy, then this is another great incentive for your employees to participate. They will need to keep in mind that the subsidy does count toward their annual pre-tax contribution limit, meaning the employer subsidy plus pre-tax contributions can’t exceed $5,000.

  3. 03

    Make it clear to employees that the funds in their health care FSAs are completely separate from the funds in their dependent care FSAs. A health care FSA allows employees to set aside pre-tax dollars to pay for their eligible medical care or the medical care of their dependents. The funds in the two accounts cannot be comingled, and unused funds from one account cannot be used to fund the other account.

  4. 04

    Dependent care FSAs are funded differently than medical FSAs. Unused funds at the end of the year are forfeited. They cannot be returned to the employee nor can they be carried over to the next plan year. Additionally, balances are not pre-funded. The amount available to pay expenses is based on contributions less any claims paid. For example, if a participant contributes $400 a month, but has a $500 claim for an eligible payment in January, then the plan only pays $400 until another contribution is made in February.

  5. 05

    Employees can leverage timing of payments to manage their out-of-pocket expenses. Long-time dependent care FSA users learn to pay the first week, submit a claim and then use that reimbursement to pay the subsequent week, submit another claim and so on. Getting in the habit of timing reimbursements with future payments will ease the financial burden.

  6. 06

    Typically, the fastest way for participants to get reimbursed is to set up direct deposit with the claims administrator.

  7. 07

    If your benefit administrator offers an app and virtual signature for the care provider, then employees can submit claims and documentation in one action.

  8. 08

    All claims must be substantiated, and the claim administrator will need (at a minimum) documentation that includes the dates when care was provided; who provided the care (name, address, and possibly tax identification or social security number); a description of the care; and amount charged. Credit card receipts, cancelled checks and balance due statements typically don’t provide all the needed information.

  9. 09

    Eligible services can only be paid from the plan year in which the care was provided. This can be problematic for plan years that follow the calendar year. Using the week of December 28, 2020, as an example, expenses for Monday through Thursday would be reimbursed from the 2020 plan year, while Friday, January 1, 2021, would be reimbursed from the 2021 plan year.

  10. 10

    Enrolling in a dependent care FSA is typically done once a year during annual enrollment. Employees are generally locked into the amount they elected when they enrolled with no midyear changes allowed — unless there’s a change in family status (i.e., birth, divorce, marriage or death). Other permitted changes that an employer may allow include change in the cost of day care, loss of dependent eligibility (e.g., child turns 13 or disabled adult is now able to care for himself or herself), and a change of employment status for your or your spouse.

Conclusion

There's a lot more to dependent care FSAs than meets the eye. Given the variety of eligible dependent care expenses, it’s important for employers to communicate what is and isn't allowed to help employees plan their contributions accurately and maximize their savings. Used appropriately, this powerful, simple tool helps employees take care of their loved ones by using pre-tax dollars for dependent care expenses.

Author

Senior Director, Benefits Accounts

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