Pandemic Relief for Dependent Care Assistance Programs

June 21, 2021

Running a business is never easy. Although most employers are used to dealing with unexpected challenges, no one was prepared for what happened in 2020. The COVID-19 pandemic changed everything. With little warning, employers had to come up with an entirely new way of doing business. Some employers had to drastically reduce their employees’ hours or were forced to go out of business. Millions of individuals lost their jobs.

In the last year, Congress has passed multiple bills to relieve some of the pandemic pain. Some of these bills create much-needed flexibility to employers that offer dependent care assistance programs (DCAPs). In particular, three pieces of legislation brought temporary, but significant, changes to DCAPs: The Coronavirus Aid, Relief, and Economic Security Act, the Consolidated Appropriations Act, 2021, and the American Rescue Plan Act of 2021. This article summarizes the pandemic relief, reviews the interactions between each provision, and provides additional items for consideration.

Special Grace Period or Carryover Feature

For plan years ending in 2020 or 2021, the Consolidated Appropriations Act, 2021 (CAA) permits employers to amend their DCAPs to allow either a special grace period (up to 12 months) or a special carryover feature. Without this expanded flexibility, an employer could offer the normal grace period (up to 2½ months) but could not adopt a carryover feature. An employer that adopts a special grace period or carryover feature may design its DCAP to limit the maximum grace period. Each feature allows participants to use any remaining contributions in the following plan year.

Special Grace Period Example: An employer with a calendar year plan adopts the special 12-month maximum grace period feature for the 2020 plan year. The DCAP participants can incur expenses from January 1, 2020, through December 31, 2021.

Special Carryover Example: An employer with a calendar year plan adopts the special carryover feature for the 2020 plan year, allowing DCAP participants to carry over any remaining account balance from the 2020 plan year into the 2021 plan year and use the carryover for expenses incurred from January 1, 2021, until December 31, 2021.

In Notice 2021-15, the IRS clarified that adopting a grace period or a carryover feature will not affect the annual DCAP contribution limit. In particular, unused amounts that are carried over from prior years or that are available during a grace period are disregarded when determining the following year’s annual limit. Similarly, amounts that are carried over from prior years or that are available during a grace period are not included in nondiscrimination testing.

NOTE: The special grace period or carryover feature applies only for plan years 2020 or 2021. Beginning with plan years ending in 2022, the special grace period and carryover feature will no longer be available. If an employer adopted a special grace period, the grace period will be reduced to 2½ months; if the employer adopted a carryover feature, the carryover will no longer be available.

Special Age-Limit Rule

The CAA also allows employers to amend their plans and adopt a special age-limit rule when a dependent “ages out” during the pandemic. Traditionally, DCAP funds are used to pay for expenses incurred for a dependent who is 12 years old or younger. Under the special age-limit rule, an employer may adopt an amendment to permit expense reimbursements for dependents who are 13 years old or younger. And participants who enrolled in the plan before January 31, 2020, may carry over unused amounts to a subsequent plan year for a dependent turning 13. Any amount used under the special age-limit rule is limited to the amount carried over (i.e., the unused balance from the prior year). So any amount contributed in the subsequent plan year cannot be used for a dependent who is 13 years old; it is limited to dependents who are 12 years old or younger. Employers are permitted to adopt the special age-limit rule without adopting the special grace period or carryover feature (and vice versa).

Special Age-Limit Rule Example: An employer with a calendar year plan adopts the special age-limit rule for the 2020 plan year (January 1, 2020, to December 31, 2020). A participant enrolls in the plan on January 15, 2020, and contributes $1,500 to the plan. The participant has no expenses in plan year 2020, so the entire $1,500 is carried over into the 2021 plan year. For the 2021 plan year, the participant contributes $5,000. One of the participant’s dependents turns 13 in 2021 and incurs $2,000 in expenses. The participant may be reimbursed only $1,500 for the dependent who turned 13 (i.e., aged out). The remaining $500 cannot be reimbursed; only the amount that is carried over can be used to reimburse expenses for a dependent who turns 13. The remaining $5,000 account balance may be used to reimburse expenses for any dependent who is 12 years old or younger.

Increased Annual Limit

For the 2021 tax year only, the American Rescue Plan Act of 2021 (ARPA) increases the DCAP limit from $5,000 to $10,500 for married taxpayers filing jointly and from $2,500 to $5,250 for married taxpayers filing separately. Because the increased limit is tied to the tax year, employers with non-calendar year plans must take special care that contributions do not exceed the limit for the 2020, 2021, and 2022 tax years. And because the increased limit is subject to nondiscrimination rules (absent additional guidance from the IRS), employers should be cautious when implementing this change.

Examples:

1) Calendar Plan Year

2) Non-calendar Plan Year (July 1 to June 30)

For the 2020 plan year, the employee elects to contribute $5,000, but incurs no dependent care expenses. The employee is permitted to carry over $5,000 into the 2021 plan year. For the 2021 plan year, the employee elects to contribute $10,500 to the plan. The employee does not incur any dependent care expenses during the 2021 plan year. Beginning on January 1, 2022, the employee has $15,500 in available benefits. For the 2022 tax year, only $10,000 is excludable from income because $5,000 is the maximum carryover and $5,000 is the permitted contribution for the 2022 tax year. The remaining amount, if reimbursed, is taxable.

Midyear Election Changes

For plan years ending in 2021, the CAA extends the Coronavirus Aid, Relief, and Economic Security (CARES Act) relief by allowing employers to adopt an amendment that permits prospective midyear election changes without requiring a change in status. This includes prospective election changes to revoke an election, make an election, or increase or decrease an existing election. Employers have flexibility when designing their plans by limiting

the election amounts to no less than amounts already reimbursed;
the period within which to make an election change;
the number of times a participant may make an election change; and
the use of amounts contributed following a revocation (i.e., amounts may be used for expenses incurred before the revocation date, or amounts may remain available for the remainder of the plan year).

While election changes are prospective, employers may allow participants to use contributed amounts retroactive to the first day of the plan year beginning on or after January 1, 2021. This relief does not permit any amount to be paid to participants in the form of cash or any taxable or nontaxable benefit without taking into account dependent care expenses incurred during the period of coverage. The following examples demonstrate different ways that participants can take advantage of this new rule.

Prospective Election Change: An employer amends its plan to permit a prospective election change for its plan year ending in 2021. A participant initially declined enrollment in the DCAP, but decides to prospectively enroll in the plan on May 1, 2021, after the amendment.

Retroactive Effective Date: An employer amends its plan to allow participants to use contributed amounts retroactively for expenses incurred on or after January 1, 2021. A participant chooses a prospective election effective May 1, 2021, but incurs $1,500 in expenses between January 1, 2021 and April 30, 2021. Because the employer has adopted an amendment that permits retroactive reimbursements following a prospective election, the participant may be reimbursed for these expenses.

Conclusion

These pandemic relief provisions can significantly help participants. But employers should carefully consider all options before deciding whether to amend their plans. Employers who decide to amend their plans must then decide whether to amend retroactively or prospectively. For retroactive amendments, employers must:

adopt the amendment by the last day of the first calendar year beginning after the end of the plan year in which the amendment is effective,
operate the plan consistent with the terms of the amendment during the period beginning on the amendment’s effective date and ending on the amendment’s adoption date, and
inform all employees eligible to participate of the changes in the plan.

Employers should consult competent legal counsel for additional questions or concerns.