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July 8, 2020
Potential Impact of COVID-19 on Dependent Care Flexible
Spending Arrangements (FSAs)
Dependentcare flexible spending arrangements (FSAs) are
a benefit that employers may offer employees. They allow
employees to pay for certain dependent care services (e.g.,
child care, sumner day camp, babysitting, and adult day
care expenses) with pretaxdollars. Dependent care FSAs
are also referred to as dependentcare assistanceplans
(DCAPs). Employees who participate in a dependent care
FSA choose to have aportionoftheir salary set aside ona
pretaxbasis (i.e., not subject to federalincome orpayroll
taxes), generally up to a maximum of $5,000 per year.
There are other types of FSAs. Health FSAs, for example,
allow employees to pay for eligible health care expenses
with pretax dollars. For a discussion of health FSAs in the
context of the Coronavirus Disease 2019 (COVID-19)
pandemic, see CRS In Focus IF11576, Potential COVID-]9
Impacts on Health Flexible SpendingArrangemen ts (FSAs)
and Recent Health FSA Changes.
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Dependent care FSAs are offered to employees as part of a
cafeteria plan. Under a cafeteria plan, employees are
offered the option to set aside a portion of their salary on a
pretaxbas is. Employees then use these contributions to pay
for expenses incurred for a qualified benefit. Generally,
under a dependent care FSA, employees pay out of pocket
for the expenses and are then reinibursed fromtheir FSA.
By using an FSA, employees reduce theincome and payroll
taxes they owe. For example, an employee subject to a 22%
income taxrate who has $1,000 of dependent care expenses
would save $296.50in taxes ($220 in federalincome taxes
and $76.50 in Social Security and Medicare payrolltaxes)
by paying for those expenses through an FSA rather than
paying out of pocket (i.e., with after-tax dollars).
Dependent care FSAs iust meet therequirements of both
InternalRevenue Code (IRC) § 129 and IRC § 125 for an
employee to receive the taxbenefits associated with
contributing to a dependent care FSA. IRC § 129 governs
employer-sponsored dependent care benefits broadly.
(Employer-sponsored dependent care benefits can be
provided in various forms, including as a dependent care
FSA, but also on-site child care and directpayments to
dependentcare providers.) IRC § 125 governs cafeteria
plans. These two sections are discussedin more detail
below.
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Under an employer-sponsored dependent care benefit
governed bylRC § 129, an employee may contribute up to
$5,000 per year to a dependentcare FSA (this maximum
applies to alltaxpayers who file their taxes as single, head
of household, or married filing jointly). This section also
defines dependent care assistance as expenses for the cane
of an employee's dependent that allowthe employee tobe
gainfully employed (as defined for the child anddependent
care credit [IRC § 21]). Dependents may include, but are not
neces sarily limited to, an employee's children, elderly
parents, or other dependent family members.
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Under a cafeteria plan governedby IRC § 125, employees
typically determine the amount they wish to contribute to
an FSA at the beginning ofaplanyear. Plan years are
usually annualperiods during which employees may
contribute to and be reimbursed froman FSA. Once an
employee has set the amount he or she wishes to contribute
to an FSA for a plan year, changes are allowed only in
limited circumstances (like the birth of a child or marriage),
generally referred to as a qualifying life event. Plan years
may begin and end at any point in the calendar year.
Under a cafeteria plan, FSA contributions are subject to a
us e-or-lose rule, whereby employees forfeit any unused
contributions remaining in their dependent care FSA at the
end of the plan year. Specifically, when an employer
chooses to offer a dependent care FSA, it generally iu s t
select one oftwo mutually exclusive options for handling
any unused balances at the end of the plan year:
1. employees forfeit unused FSA balances,
which then revert to the employer; or
2. employees are given a graceperiod ofup to
two and a half months after the end of the plan
year. Employees can be reimbursed for
dependent care expenses incurred during this
additional time. At the end of the grace peiod,
unused amounts are forfeited and revert to the
employer.
The us e-or-loserule ensures thata cafeteria plan is not
used to defer compensation (and the taxes paid on that
compensation) to a future date, which is generally
prohibited under IRC § 125.
Under current law and regulations, employees are not able
to cash outthe balance of an FSA, evenifthey were to
pay taxes on this amount. FSA contributions may only be
used to pay for qualified expenses through the plan.
Because cafeteria plans are offered by employers to their
employees, individuals may lose access to these benefits
when they are laid off or choose to leave ajob. Employers
may offer some flexibilities to departing employees.
Generally, employers may treat unused contributions in a
departing employee's dependent care FSA in the following
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