A Dependent Care Assistance Program (DCAP) reimburses an employee for qualified dependent care expenses on a tax free basis. Employees are permitted to make pre-tax contributions through a Section 125 Cafeteria Plan. The maximum benefit per calendar year is $5,000. For a married couple filing separate tax returns, the limit is $2,500 each.
An expense is eligible to be reimbursed under a DCAP if it meets the following criteria:
- The employee (and spouse, if applicable) must be gainfully employed, actively looking for employment, or a full time student.
- The expense must be for care, which means that the primary function of the care is to ensure the individual's well-being and protection.
- The expense must be for a qualifying individual, which includes a dependent child, the spouse, or other tax dependent. If the dependent is over the age of 13, the individual must be incapable of self-care.
- The expense was incurred during the participant's period of coverage.
As with other reimbursement accounts, the expenses must be substantiated by a third party verifying the service provided, the date the expense was incurred, and the expense amount.
A DCAP must not discriminate in favor of employees who are highly compensated employees, shareholders, or owners. There are four tests that must be performed on current plan year data. They are the: Eligibility Test, Contributions and Benefits Test, More than 5% Owners Concentration Test, and the 55% Average Benefits Test. If a plan is found to be discriminatory, the amount contributed by the highly compensated employees is no longer tax-qualified under the plan and must be included in taxable gross income. The DCAP administrator should be conducting testing on an annual basis.
Under the Section 125 qualifying event rules, when may an employee change their dependent care account election?
An employee may change their election under a DCAP following certain qualifying events including marriage, divorce, birth, adoption, spouse beginning employment, spouse terminating employment, and change in day care provider. This list is not all inclusive. Please contact your adviser for assistance with specific situations.
IRS Publication 503 – This provides information on what expenses the IRS considers eligible for reimbursement and guidance for individuals wanting to claim the Child and Dependent Care Tax Credit.
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