A well-rounded benefits package is an imperative for most employers. Although health insurance and retirement plans are the most common, there are many other fringe benefits available to consider. For example, dependent care Flexible Spending Accounts (FSAs) are among the most popular for organizations that employ workers who also happen to be parents, caregivers, or both.

Purpose & Features

Sponsoring dependent care FSAs begins with implementing a dependent care assistance program (DCAP). Under this program, an employer sponsors — and retains ownership of — FSAs for employees to pay for eligible expenses that generally include:

• Daycare
• Before- and after-school care
• Summer day camps
• Care for dependent adults who can’t care for themselves

 
Any qualifying expense must enable a participant (and, if applicable, a spouse) to work or seek employment.

DCAP participation is voluntary. Employees need to opt in, typically during the employer’s open enrollment period or after experiencing a qualifying life event. Once they do, participants make pretax compensation deferrals to their accounts, up to $5,000 annually per household or $2,500 for those married but filing separately. (These amounts aren’t indexed for inflation).

Important: Because dependent care FSAs are employer owned, they aren’t “portable” if employees leave their jobs. Moreover, under the “use it or lose it” rule, account balances don’t roll over from year to year. Unused account funds generally revert to the employer at year end. (IRS rules govern such forfeitures).

Mutual Advantages

For employers, sponsoring dependent care FSAs offers several potential advantages. First, like any desirable fringe benefit, these accounts can help attract strong job candidates and retain employees — especially working mothers and fathers, as well as those caring for adult dependents such as elderly parents or others.

Second, because participants’ contributions occur pretax, they’re exempt from Social Security and Medicare taxes. That reduces the payroll tax burden for the employer and the employees. To increase participation, you may make contributions to employees’ accounts. However, the $5,000/$2,500 contribution limit still applies to combined employer-employee contributions. Also, you can’t deduct contributions as a business expense.

Of course, dependent care FSAs also offer significant advantages for eligible employees. Using pretax dollars to fund their accounts allows them to pay for qualifying care while reducing their taxable incomes. In addition, learning how to operate their FSAs enables participants to more mindfully manage dependent care expenses, making them more informed consumers.

Responsibilities & Risks

Sponsoring dependent care FSAs for employees who want them does come with considerable administrative and compliance responsibilities.

You’ll need to make sure your DCAP complies with IRS regulations. These include nondiscrimination rules that prevent benefits provided under the program from disproportionately favoring highly compensated employees over non-highly compensated ones. Failure to comply can jeopardize the program’s tax-advantaged status.

In addition, proper recordkeeping, timely reimbursements, and clear communication are critical. Regarding that last point, educating and reminding participants about the “use it or lose it” rule is particularly important. Many novice dependent care FSA users can be frustrated, if not completely demoralized, by losing their account balances at year end. Training participants on how to estimate expenses and submit claims can promote mindful and fulfilling account usage.

Perhaps the greatest risk, however, is investing time and resources into designing a DCAP and launching FSAs — only to find minimal employee interest. So, use a benefits survey and other feedback methods to help ensure the effort will be worthwhile.

Intriguing Strategy

For many employers — especially those with relatively stable full-time workforces — dependent care FSAs can serve as a practical, valued feature of their benefits packages. If you’re considering implementing a DCAP that offers FSAs, or another type of DCAP, we’re here to help. Contact us and we can assist you and your leadership team in assessing the strategy and learning more about a program’s setup, administration, and tax considerations.