Child care is one of the most expensive things an employee might budget for in any given year.

What if there was a way to lessen the burden, on a pre-tax basis – up to $5,000? 

Enter: The DCAP.

What is a DCAP?

Under the tax code, a dependent care assistance program (DCAP) is a plan allowing an employer to provide dependent care assistance benefits for their employees on a tax-free basis. They are generally referred to as DCAPs or dependent care flexible spending accounts (dependent care FSAs).

Benefits that an employee receives from his or her DCAP account are non-taxable if:

  • The expenses are for the care of one or more qualifying individuals (for example, a child under the age of 13); and
  • The employee incurs the expense in order to enable the employee (and the employee’s spouse) to be gainfully employed.

DCAP funding.

In most cases, DCAPs are funded by employees with pre-tax dollars through payroll deductions under a 125 plan. When employees incur eligible dependent care expenses, such as expenses for babysitting or child care, they can seek reimbursement from their DCAP account.

DCAPs have to comply with the requirements in Internal Revenue Code Section 129 in order to provide tax-free dependent care assistance benefits. Also, DCAPs that allow employees to make pre-tax contributions are subject to the Code Section 125 rules for cafeteria plans, including some of the rules that apply to health FSAs (excluding the uniform coverage rule).

A DCAP that reimburses employees for their dependent care expenses will rarely be subject to ERISA. So, ERISA’s requirements, including the Form 5500 reporting requirement, don’t apply to DCAPs.

DCAPs are not group health plans, which means they are not subject to requirements under many federal rules, such as: COBRA continuation coverage, the Affordable Care Act (ACA), or HIPAA. Because DCAPs are not group health plans, participating in a DCAP does not disrupt eligibility to make contributions to health savings accounts (HSAs).

How to determine if a DCAP is right for your business.

Not every employer, or employee population, however, will be able to take full advantage of a DCAP. DCAPs are subject to nondiscrimination testing (NDT) requirements and for some employers whose employees are predominantly highly compensated, or top-heavy, the program might add increased administrative burdens and minimal benefit due to a greater likelihood of NDT failures. In fact, some of the most common NDT failures relate to DCAPs. Examples of these types of businesses include legal, engineering and accounting firms as well as medical practices.

But how does a failure create an administrative burden? If a plan discovers a potential failure midyear, it can adjust employee withholdings to avoid that failure. If a failure is not discovered until after the end of the tax year, however, highly compensated employees will lose the entirety of the tax advantage of their DCA reimbursements resulting in a need to issue amended Forms W-2 to affected employees, adjusting their gross income. Not only does this create an administrative burden for employers, it can be frustrating for employees who are not able to utilize the full $5,000 limit of this benefit.

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Disclaimer: Please note that this is not all inclusive. Our guidance is designed only to give general information on the issues actually covered. It is not intended to be a comprehensive summary of all laws which may be applicable to your situation, treat exhaustively the subjects covered, provide legal advice, or render a legal opinion. Consult your own legal advisor regarding specific application of the information to your own plan.