In the past 14 months, a few Acts have been passed to help everyone during the pandemic – The Consolidated Appropriations Act of 2021 (CAA) and the American Rescue Plan Act (ARPA). Many employers have been hesitant to incorporate many of the opportunities brought on by the newly passed legislation, but HAVE NO FEAR, the recent direction isn’t scary, this temporary benefit increase will benefit both the employer and employee.
The BASE® Dependent Care Assistance Plan (DCAP) allows employees to use tax-free dollars to pay for their employment-related dependent care expenses. No matter the dependent care service, children, disabled spouse, or legal dependents, it provides additional financial assistance to take care of dependents, tax-free.
Between the two Acts, there were some definite changes to the DCAP possibilities, but some things were not very clear. What was clear was that the employee could contribute and be reimbursed from the DCAP, tax-free up to $10,500 (filing as married or $5,250 filing as single or married filing separately). What was NOT made clear, at the time, was the employee’s potential tax consequences if the employee carried over a DCAP balance from the prior year in addition to making contributions up to the $10,500 limit.
The question was answered in the form of Notice 2021-26. This notice provides the employee additional relief by allowing tax-free reimbursements of amounts carried over from the prior plan year in addition to the tax-free reimbursements made in the plan year up to the maximum limit.
HAVE NO FEAR, we understand that the notices can be confusing, so we put together a quick example below.
Cindy Johnson is a receptionist at a Law Firm and is enrolled in her employer’s calendar year DCAP. She contributes $5,000 for the plan year of 2020 but incurred no daycare expenses due to the pandemic. Her employer’s plan allowed her to carryover the unused $5,000 to the 2021 plan year. She then elects to contribute the full $10,500, since her employer opted to allow for the increase, knowing her daycare expenses for the upcoming year. Cindy’s daycare expenses are well over the $15,500 she contributes from her paycheck, but she is reimbursed up to the $15,500 limit. The $15,500 is omitted from Cindy’s gross income because it is elected on a pre-tax basis and the remaining $5,000 is due to the carryover permitted under the Act. As before, Cindy’s contribution to the DCAP is on a pre-tax basis, will save Federal, State, Social Security, and Medicare taxes. With her contributing more, Cindy will see an even bigger increase in her take home pay. With Cindy’s increase in contribution, her employer will also see an even bigger reduction in their share of payroll taxes.
A few things to note: This is just one scenario, so be sure to review Notice 2021-26 for more examples of how this might affect DCAP participants based on different plan year examples. Also note, this temporary change is optional for employer plan sponsors. The limit for this year only has been increased from $5,000 to $10,500 (or $5,250 for married individuals filing separately). Employers that wish to provide this enhanced benefit option to their plan participants must amend their plan to adopt the increased limit for the 2021 tax year. Plans can be amended retroactively to incorporate the change if the amendment is adopted no later than the end of the plan year in which it is to be effective.