May 12, 2021
On May 10, 2021, the Internal Revenue Service (IRS) released Notice 2021-26 regarding the taxability of dependent care assistance programs (DCAPs) for 2021 and 2022, clarifying that amounts attributable to previously issued carryover and extended grace period relief generally are not taxable.
In summary, carryovers of unused DCAP amounts typically are not permitted, although a 2½ month grace period is allowed. However, recent coronavirus-related relief allows employers to amend their plans to permit the carryover of unused DCAP amounts to plan years ending in 2021 and 2022, or to extend the permissible grace period to plan years over the same period. This Notice clarifies the interaction of this standard with the one-year increase in the exclusion for employer-provided dependent care benefits from $5,000 to $10,500 for the 2021 taxable year under the American Rescue Plan Act.
Specifically, if these dependent care benefits would have been excluded from income if used during the taxable year 2020 (or 2021, if applicable), these benefits will remain excludible from gross income and are not considered wages of the employee for 2021 and 2022. They will also generally not be taken into account for purposes of applying the exclusion limits of Internal Revenue Code Section 129.
FACTS: Employee elects to contribute $5,000 for DCAP benefits for the 2020 plan year but incurs no dependent care expenses during that plan year. The employer amends its plan to allow the employee to carry over the unused $5,000 of DCAP benefits to the 2021 plan year. The employee elects to contribute $10,500 for DCAP benefits for the 2021 plan year, incurs $15,500 in dependent care expenses for that plan year, and is reimbursed $15,500 by the DCAP.
CONCLUSION: The $15,500 is excluded from the employee’s gross income and wages because $10,500 is excluded as 2021 benefits and the remaining $5,000 is attributable to a carryover permitted by the previously issued coronavirus-related relief.
For additional information, please contact your Burnham Consultant or Burnham, A Baldwin Risk Partner at 949‐833‐2983 or firstname.lastname@example.org.
Burnham Benefits does not engage in the practice of law and this publication should not be construed as the providing of legal advice or a legal opinion of any kind. The consulting advice we provide is intended solely to assist in assessing its compliance with the Patient Protection and Affordable Care Act and other applicable federal and state law requirements, and is based on Burnham Benefit’s interpretation of federal guidance in effect as of the date of this publication. To the best of our knowledge, the information provided herein, and assumptions relied on, are reasonable and accurate as of the date of this publication. Furthermore, to ensure compliance with IRS Circular 230, any tax advice contained in this publication is not intended to be used, and cannot be used, for purposes of (i) avoiding penalties imposed under the United States Internal Revenue Code or (ii) promoting, marketing or recommending to another person any tax-related matter.