Dependent Care Flexible Spending Accounts: What Now?
August 31, 2020
Due to COVID-19, there has been a dramatic increase in work-from-home arrangements over the last five months. This has caused employees with Dependent Care Flexible Spending Accounts (DCFSA) to wonder what they can do with their DCFSA and how they can use existing funds. Employers now have increased flexibility to make changes to their DCFSA programs and allow employees to spend down their prior plan year DCFSA accounts. Here are some options available to employers based on IRS Notice 2020-29 and additional guidance.
Mid-Year Election Changes
NOTE: This rule is not mandatory, and employers can decide whether to allow these changes and to what extent.
The IRS increased flexibility to help participants who may have mistakenly estimated their needs (over or under) when determining DCFSA funding last year and whose care needs have changed due to COVID-19. Through December 31, 2020, mid-year annual election changes to a DCFSA qualify as a “change in status,” allowing employees to make a prospective adjustment to funds deposited into a DCFSA for any reason. Based on current IRS guidelines, funds that have previously been taken out of paychecks to fund a DCFSA cannot be pulled out or refunded – the relief only applies to future contributions.
If an employer implements the mid-year election changes, they can determine the period when employees may change their DCFSA annual elections. Once the designated time period ends, DCFSA election changes must follow the usual process provided in the plan document. Generally speaking, the IRS has been more lenient on DCFSA election changes than with health FSA election changes, which has permitted employees to change their DCFSA election based on their circumstances at any time. Employers should apply the same timing as other election changes (e.g., 60 days after the event), and base the event on the circumstances (e.g., the date the employee’s child returns to normal activities).
If an employer does not implement mid-year election changes, DCFSA elections can still be increased or decreased due to a change in the employee’s or spouse’s work schedule. For example, parents may not be paying for dependent care if their children are at home and the parents are working from home or have temporarily stopped working. As this results in lower day care costs for a parent, their DCFSA annual election may be decreased. Conversely, if the employee hires a nanny thereby increasing day care costs, the employee may increase their DCFSA annual election.
Plans with Grace Periods & Non-Calendar-Year Plans
NOTE: These rules are optional for employers and not required.
The IRS has increased flexibility for certain cafeteria plans to apply unused DCFSA funds to pay or reimburse dependent care expenses incurred through December 31, 2020. This applies to plans that have a grace period ending in 2020 or plans that do not run on a calendar year basis.
Plans with grace periods ending in 2020 – A grace period provides up to 21/2 months after the end of the plan year during which DCFSA participants may incur and be reimbursed for dependent care expenses. If the employer maintains a cafeteria plan that contains a DCFSA grace period and wishes to implement the extended period, the entire unspent 2019-2020 DCFSA balance will be available to spend through December 31, 2020.
Example: Pizza Planet has a cafeteria plan year of April 1, 2019 – March 31, 2020 and the grace period for the plan year ends on June 15, 2020. Employee Sarah has $2,500 remaining in her DCFSA account as of June 15, 2020. Sarah has until December 31, 2020 to incur dependent care expenses and submit claims for reimbursement, thereby spending down her March 31, 2020 plan year $2,500 DCFSA funds.
Non-calendar-year plans – If the employer maintains a non-calendar-year cafeteria plan and wishes to implement the extended period, the entire unspent 2019-2020 DCFSA balance will be available to spend through December 31, 2020.
Example: Big Bob’s Tires has a cafeteria plan year of April 1, 2019 – March 31, 2020 and does not provide a grace period for the DCFSA. Employee Steve has $1,000 remaining in his DCFSA account as of March 31, 2020. Steve has until December 31, 2020 to incur dependent care expenses and submit claims for reimbursement, thereby spending down his March 31, 2020 DCFSA balance.
What Hasn’t Changed About Dependent Care Reimbursement
Remote work
If an employee is working remotely and incurring dependent care expenses (e.g., for a nanny), these expenses are eligible for reimbursement. The employee is considered gainfully employed since they are working from home. However, if there is a non-working spouse at home, dependent care expenses are not eligible for reimbursement.
Work absence due to illness
If the absence is longer than two weeks, dependent care expenses incurred during the absence are not eligible for reimbursement. Illness, including COVID-19, is not a valid reason to continue incurring dependent care expenses during a leave.
Work suspension
The IRS has strict rules requiring that an employee must be employed or seeking employment for dependent care expenses to be eligible for reimbursement. If parents are not working due to a COVID-19 related work suspension, dependent care expenses incurred during that time would not be eligible for reimbursement. The IRS makes an exception if the absence is two weeks or less.
Claims submission deadline
Even if an employer has implemented the extended period of time to allow participants to incur and be reimbursed for dependent care expenses, any amount remaining in the account as of the claim’s submission deadline will be forfeited. The IRS cannot provide relief from the “use it or lose it” rule. Employees should continue to assess their DCFSA expenses throughout the year and, if there is a change in costs or circumstances, should determine if they are eligible to change their annual DCFSA election.