What is a Dependent Care FSA? Everything you need to know

Access to affordable healthcare is high on the priority list for most workers, and if coverage extends to dependents within the family, the pot gets even sweeter.

Employers that offer family healthcare benefits as part of their compensation package are more likely to attract and retain top industry talent, but the cost of running such programs can be quite high. Fortunately, there is a way to keep costs down while offering quality healthcare benefits at scale, namely Flexible Spending Accounts or FSAs.

FSAs are designed to help employees pay for qualified medical expenses with tax-free dollars they set aside through payroll deductions. But what makes FSAs enticing to employees is the option to extend coverage to other members of the family through Dependent Care Flexible Spending Accounts (DCFSAs).

Let’s explore how DCFSAs can make your compensation package truly stand out.

Key Takeaways

• A Dependent Care FSA provides participants with immediate tax savings by allowing them to contribute pre-tax dollars towards eligible dependent care expenses, reducing their taxable income.
• Participants can gain pretax childcare, preschool, and other qualified dependent care services, easing the financial burden associated with work-related caregiving responsibilities.
• Including a Dependent Care FSA in the benefits package can boost recruitment efforts and increase employee retention, as it addresses a critical aspect of work-life balance for working parents.
• Employers benefit from reduced payroll taxes as employees contribute to the Dependent Care FSA with pre-tax dollars, resulting in potential cost savings for both the employer and the workforce.

What is a Dependent Care Flexible Spending Account (DCFSA)?

A Dependent Care Flexible Spending Account (DCFSA) is an employer-sponsored benefit that allows employees to set aside pre-tax dollars to cover qualified dependent care expenses. It provides tax savings and helps individuals manage costs associated with childcare, preschool, daycare, and other eligible services.

If you want to learn more about FSAs in general, check out What is a Flexible Spending Account.

How does a Dependent Care FSA work?

Dependent Care FSAs work much in the same way as regular FSAs, with a few notable differences (more on that later). Here is an outline of how FSAs operate:

1. Enrollment stage – The employer gives out a notice about open enrollment, throughout which employees can elect to participate in a DCFSA if they’re eligible. Employees can decide how much money they want to contribute to the account for the plan year up to the annual contribution limit set by the IRS.
2. Pre-tax contributions – The amount employees choose to contribute is deducted from their salary before taxes are applied. This reduces taxable income, leading to potential tax savings.
3. Qualified expenses – The funds in a DCFSA can be used to pay for eligible dependent care expenses. Qualified expenses typically include: daycare expenses for children under the age of 13, before and after-school care, summer day camps, and care for a disabled spouse or elderly parent, if they qualify as dependents.
4. Incurred expenses – When an employee incurs eligible dependent care expenses throughout the plan year, they can submit reimbursement claims to a FSA administrator.
5. Reimbursement process – The FSA administrator reviews reimbursement claims to ensure they meet the eligibility criteria. Once approved, the employee is reimbursed with funds from their DCFSA.
6. Use-it-or-lose-it rule – Any funds remaining in a DCFSA at the end of the plan year are forfeited. However, the Consolidated Appropriations Act, 2021, introduced the option for employers to offer a carryover of up to $550 or a grace period of up to 2.5 months for unused funds.
7. Plan year and renewal – A Dependent Care FSA typically operates on a plan year basis, usually coinciding with the calendar year. During each open enrollment period, employees need to re-enroll, and they can make changes to their contribution amount for the upcoming plan year.

If you’re interested in other types of pre-tax healthcare arrangements, head on to Forma’s pre-tax accounts for details.

Healthcare FSA vs Dependent Care FSA

Healthcare FSAs and DCFSAs are employer-sponsored benefit accounts that allow employees to set aside pre-tax dollars to cover specific expenses. However, they serve different purposes and cover different types of expenses.

Here's a comparison between the two, expressed in terms of key features.

Purpose

• Healthcare FSA – Designed to cover eligible healthcare expenses for the account holder. Healthcare FSAs are sometimes called Healthcare Spending Accounts.
• DCFSA – Designed to cover eligible dependent care expenses for the account holder's dependents, such as children, disabled spouses, or elderly parents.

Eligible expenses

• Healthcare FSA – Covers a wide range of qualified medical, dental, and vision expenses, including copayments, deductibles, prescription medications, and certain over-the-counter items with a prescription.
• DCFSA – Covers expenses related to the care of dependents, including daycare, preschool, before and after-school care, and summer day camps.

Reimbursement process

• Healthcare FSA – Participants often receive a debit card linked to their HCFSA (such as the Forma Card) for direct payment at the point of service, simplifying the reimbursement process. Some expenses may still require documentation for verification.
• DCFSA – Participants pay for eligible dependent care expenses out of pocket. Reimbursement requires submitting claims with documentation (receipts, provider information) for verification. There is no direct payment option like a debit card.

Dependent coverage

• Healthcare FSA – Typically covers eligible healthcare expenses for the account holder.
• DCFSA – The dependent must be 12 years old or younger, or older than 13, and physically or mentally incapable of self-care.

• Healthcare FSA – The contribution limit for Healthcare FSAs is set by the IRS on an annual basis, and for 2024 it’s $3,200. 
• DCFSA – The contribution limit for DCFSAs for 2024 is $5,000 per household or $2,500 if married, filing separately.

Note that employees can contribute to both types of FSAs concurrently, but the combined annual contribution limit applies.

Carryover or grace period

• Healthcare FSA – Employers can choose to offer either a carryover of up to $550 or a grace period of up to 2.5 months for unused funds. However, they are not required to offer either option.
• DCFSA – Similar to the HCFSA, employers can choose to offer either a carryover of up to $550 or a grace period of up to 2.5 months for unused funds. However, they are not required to offer either option.

Health care FSA vs DCFSA comparison table

DCFSA vs Child and Dependent Care Tax Credit

The Child and Dependent Care Tax Credit (CDCTC) is a tax benefit provided by the US government to help eligible taxpayers with the costs of child and dependent care. It is designed to help individuals who work by providing them with pretax childcare.

DCFSAs and CDCTCs are two different ways to help offset the costs of dependent care expenses, but they have distinct features. Let’s look at what makes CDCTCs unique as a mechanism for offsetting dependent care costs.

CDCTC overview

CDCTCs is a federal tax credit designed to provide tax relief to individuals who incur qualifying dependent care expenses. It is available to taxpayers who meet specific income and eligibility criteria.

The credit percentage for CDCTC ranges from 20% to 35% of qualifying expenses, depending on the taxpayer's adjusted gross income. This provides a direct reduction in the amount of federal income tax owed, potentially resulting in a larger tax benefit for lower-income individuals.

In terms of eligible expenses, the CDCTC covers a similar set of qualifying dependent care expenses, such as daycare, preschool, and summer day camps.

Unsure which FSA is best for your employees' needs? <span class="text-style-link text-color-blue"fs-mirrorclick-element="trigger"role="button">Schedule a consultation</span> with one of our experts to explore innovative and tailored benefits solutions that align with your team's unique healthcare needs.

What are the benefits of Dependent Care FSAs?

Offering DCFSAs in your organization provides several advantages, contributing to both employee well-being and overall business success. They are similar to the benefits of FSAs, for the most part, with a couple of nuances.

Here are the five key benefits of DCFSAs.

Enhanced employee satisfaction and retention

DCFSA benefits demonstrate a commitment to supporting employees in managing their work-life balance. By helping alleviate the financial burden of dependent care expenses, employers can enhance overall job satisfaction and increase the likelihood of retaining valuable talent.

Tax savings for employers and employees

Employers and employees both benefit from DCFSA contributions being made on a pre-tax basis. Employers experience reduced payroll taxes, and employees see immediate tax savings as their taxable income is lowered, resulting in more take-home pay.

Improved recruitment and competitive positioning

Offering DCFSA as part of a comprehensive benefits package enhances an employer's attractiveness to potential candidates. In a competitive job market, robust benefits, including DCFSA, can be a compelling factor for attracting and recruiting top talent.

Increased productivity and reduced absenteeism

When employees have access to a DCFSA, they are better equipped to manage the costs of dependent care, reducing stress and distractions related to financial concerns. This, in turn, can lead to increased focus, productivity, and a potential decrease in absenteeism.

Family-friendly workplace culture

Providing DCFSA underscores a commitment to creating a family-friendly workplace culture. Employers that prioritize the needs of working parents and caregivers are likely to foster a positive and inclusive atmosphere, promoting employee loyalty and engagement.

Dependent Care FSAs rules and requirements

The rules and requirements for DCFSAs are governed by the IRS. Employers must adhere to these guidelines when offering DCFSA benefits to their employees.

Here are key rules and requirements:

• Taxable income requirement – Participants must have taxable income to contribute to a DCFSA. Pre-tax contributions are deducted from the employee's salary, reducing their taxable income.
• Annual contribution limits – The IRS sets annual contribution limits for DCFSA. The limit is $5,000 for individuals or married couples filing jointly and $2,500 for married individuals filing separately.
• Use-it-or-lose-it rule – DCFSA funds are subject to the use-it-or-lose-it rule, meaning any unused funds at the end of the plan year are forfeited. However, employers can offer either a carryover of up to $550 or a grace period of up to 2.5 months for unused funds.
• Eligible expenses – DCFSA funds can only be used for qualified dependent care expenses. 
• Reimbursement process – Participants pay for eligible expenses out of pocket and submit claims for reimbursement. Documentation, such as receipts and provider information, is required for verification.
• Dependent care provider information – Participants need to provide information about their dependent care providers, including the provider's name, address, and taxpayer identification number (TIN).

What can a Dependent Care FSA be used for?

A DCFSA can be used to cover a variety of qualified dependent care expenses. To make eligible expenses, it's necessary for the employee (and, if applicable, the spouse) to work or, in certain cases, even under unemployment, given that you receive unemployment benefits and your previous employer allows it but this typically does not happen..

Expenses like private school tuition, overnight camp costs, and extracurricular activities without an educational component are generally not eligible for reimbursement through a DCFSA.

DCFSA eligible expenses: what qualifies for It?

Here is a non-exhaustive list of expenses eligible for reimbursement through DCFSAs:

• Daycare expenses – Payments to a licensed daycare center or in-home daycare provider for the care of children under the age of 13.
• Preschool programs – Tuition and fees for preschool programs that focus on early childhood education.
• Before and after-school care – Expenses incurred for programs that provide care for children before or after regular school hours.
• Summer day camps – Day camp expenses during the summer months, as long as the camp provides a structured program and is not an overnight camp.
• Nursery school fees – Fees for nursery schools that focus on early childhood education.
• Disabled dependent care – Expenses related to the care of disabled dependents, such as a disabled spouse or elderly parent, who lives with the taxpayer and is incapable of self-care.
• Transportation to care facilities – Transportation costs directly related to the care of a dependent, such as transportation to and from a daycare center.
• Before and after-school enrichment programs – Fees for programs that offer educational and recreational activities for children outside of regular school hours.
• Household services – Services that are directly related to the care of qualifying dependents and enable the employee (and, if married, the spouse) to work or actively look for work.

If you want to make sure that your dependent care expenses are eligible for DCFSA reimbursement, it’s best to talk to a healthcare tax expert.

Who is eligible for a Dependent Care Flexible Spending Account?

Eligibility for a DCFSA is determined by the employer and must adhere to guidelines set by the IRS. In general, individuals may be eligible to participate in a DCFSA if they meet the following criteria:

• Employment status – Participants must be currently employed and actively earning income. DCFSA contributions are typically made through salary deferrals, so individuals without taxable income may not be eligible.

• Qualifying dependents – Participants must have eligible dependents for whom they incur dependent care expenses. Eligible dependents include:

• Children under the age of 13.
• A spouse who is physically or mentally incapable of self-care.
• Other dependents who are physically or mentally incapable of self-care and live with the taxpayer.

• Marital status – The eligibility rules may vary, but generally, both single and married individuals can participate in a DCFSA. However, if married, both spouses must be working or full-time students (varies employer-to-employer).

• Dependent care expenses – Participants must have qualifying dependent care expenses that are necessary for the individual (and, if applicable, the spouse) to work or actively seek employment.

Is a Dependent Care FSA worth It?

A DCFSA is beneficial to both employers and employees for a number of reasons.

First, it allows participants to pay for eligible dependent care expenses with pre-tax dollars, providing immediate tax savings. 

Second, it helps individuals manage the costs associated with childcare, preschool, and other dependent care services, promoting work-life balance. 

Third, contributing to a DCFSA can result in increased take-home pay, as taxable income is reduced.

Fourth, by utilizing a DCFSA participants may be eligible for valuable tax credits, such as the Child and Dependent Care Tax Credit (CDCTC), further maximizing savings.

Finally, offering DCFSA benefits can enhance employee satisfaction and retention, contributing to a positive workplace culture.

Overall, the potential tax savings and financial benefits make a Dependent Care FSA a valuable option for individuals with qualifying dependent care expenses.

If you want a convenient and scalable way to offer DCFSAs at your organization, Forma provides a benefits platform for managing and providing a variety of healthcare benefits.

<span class="text-style-link text-color-blue" fs-mirrorclick-element="trigger" role="button">Schedule a consultation</span> with one of our experts to find a flexible spending account plan that’s best for meeting all your employees’ needs.

*This document is for informational purposes. Forma is not engaged in the practice of law. Nothing contained herein is intended as tax or legal advice nor is it intended to replace tax or legal advice from counsel. If you need tax or legal advice, please consult with counsel or a certified tax professional.

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