IRS Addresses Tax Treatment of DCAP Benefits Available Under Extended Claims Period or Carryover

The IRS has provided guidance regarding the federal tax treatment of DCAP benefits that continue to be available in taxable years ending in 2021 or 2022 because of an extended claims period or carryover offered pursuant to the COVID-19 relief provisions of the Consolidated Appropriations Act, 2021 (CAA, 2021) (see our Checkpoint article). The guidance explains that amounts available under an extended claims period or carryover provision that would have been excluded from employees’ income if they had been used during the taxable year ending in 2020 or 2021 (as applicable) will remain excludable if used for dependent care benefits during the following taxable year. Furthermore, those benefits are not counted toward the maximum DCAP exclusion amount that applies to other DCAP benefits available for the 2021 and 2022 taxable years.

The guidance also explains how the temporary increase in the maximum DCAP exclusion under the American Rescue Plan Act of 2021 (ARPA) (see our Checkpoint article) affects non-calendar-year plans. Under ARPA, the maximum amount of DCAP benefits that can be excluded from income is temporarily increased from $5,000 to $10,500 (or from $2,500 to $5,250 for taxpayers who are married filing separately) for taxable years beginning in 2021. Because the increase applies to an individual’s taxable year (typically the calendar year) and not the plan year, the increased exclusion amount will not apply to a non-calendar-year DCAP’s reimbursements for expenses incurred in the 2022 portion of the 2021 plan year (i.e., the plan year that begins in 2021). Thus, if a non-calendar-year DCAP reimburses more than $5,000 for the 2021 plan year, a portion of the employee’s DCAP contributions for that plan year may become taxable if used to reimburse expenses incurred in 2022. According to the guidance, DCAP benefits from one taxable year that are used to reimburse expenses incurred in the next taxable year but during the same non-calendar plan year that spans those two taxable years are not carryover benefits or benefits available under an extended claims period; thus, the guidance does not apply to those benefits. Detailed examples are provided to illustrate the impact of the guidance and temporary ARPA increase under calendar- and non-calendar-year plans.

EBIA Comment: The guidance offers additional relief to employees who were unable to use their DCAP contributions in 2020 and 2021 due to the COVID-19 pandemic. It is recommended reading for anyone who works with DCAPs that are offering extended claim periods or carryovers. In particular, those who administer or advise non-calendar-year DCAPs will want to work through the examples to ensure they understand how the rules apply to those plans. For more information, see EBIA’s Cafeteria Plans manual (which will be updated for this development) at Sections XVI.N (“Temporary COVID-19-Related Relief for Cafeteria Plans, Health FSAs, and DCAPs”), XXIV.I (“Exclusion Is Limited to $5,000/$2,500 or Employee’s/Spouse’s Earned Income”), and XXV.D (“Non-Calendar-Year DCAPs Raise Various Issues”).

Contributing Editors: EBIA Staff.