Employer-Sponsored Benefit Plans

What to Know About Dependent Care Assistance Program (DCAP) Reimbursements After a Midyear Termination

One common configuration of employee benefits today is a cafeteria plan with options for pre-tax contributions that include a health Flexible Spending Account (FSA) and a dependent care FSA, also commonly referred to as a DCAP.

The health FSA pays for or reimburses out-of-pocket medical expenses for employees and their families, while the DCAP can be used for child or elder daycare and similar expenses for qualifying dependents — such as children, a disabled spouse, or legally dependent parents.

However, a issue many employers encounter is what to do when a DCAP participant’s employment terminates mid-year with unused DCAP contributions. Can this person be reimbursed for expenses incurred after termination of employment, or must they forfeit the unused contributions? The answer depends on the terms of your plan.

Proposed regulations

Unlike health FSAs, DCAPs are not subject to the Consolidated Omnibus Budget Reconciliation Act. So, DCAP participants generally have no right to continue coverage after their employment terminates.

However, proposed IRS cafeteria plan regulations allow a DCAP to be designed so employees whose participation has ceased — for example, because of termination — may be reimbursed from their remaining DCAP account balances for eligible expenses incurred during the remainder of the plan year (including any grace period immediately following the plan year, if provided).

If such a ‘spend-down provision’ is offered, it must be included in the written plan document. Note that this special rule does not extend to other benefits, such as the health FSA. The regulations also make clear that a spend-down provision is optional. If an employer does not design its plan to include it, any remaining contributions will be forfeited unless they are used to reimburse expenses incurred before the participant’s termination and submitted by the end of the DCAP’s run-out period.

Gainful employment

A DCAP can reimburse dependent care expenses only if they enable the employee (and spouse if the employee is married) to be ‘gainfully employed.’ The same rule applies to expenses incurred after termination.

Generally, ‘gainful employment’ means employed or actively looking for work. Special rules apply in certain situations — for instance, a spouse who is a full-time student or incapable of self-care may be deemed to be gainfully employed. An example in the regulations confirms that a DCAP can reimburse expenses incurred while a former employee works for an employer other than the DCAP sponsor.

Common challenge

Many of today’s employees must deal with the challenge of caring for children or aging parents (or both). Yours may appreciate the value of a DCAP, but administering these plans calls for careful attention to detail. We can provide you with more information.

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