Dependent Day Care Flexible Spending Account Plans allow employees to pay unreimbursed dependent day care expenses with pre-tax payroll reductions.
DFSA Basics
A Dependent Day Care Flexible Spending Account (DFSA) allows employees to set aside a portion of salary, before-tax, to reimburse certain amounts spent for eligible dependent day care expenses that are necessary in order for the employee, and if married, the employee’s spouse, to work or look for work.
Participating in a DFSA can help an employee save money on taxes since the money set aside is not subject to federal income or Social Security tax. This allows employees to benefit more from the money they earn.
The maximum annual DFSA contribution under federal tax law may be up to $5,000 ($2,500 maximum if the employee is married filing separate income tax returns) (for 2022, these amounts are subject to change). The terms of the employer’s plan may set lower contribution limits. A contribution may not exceed the employee’s earned income or the employee’s spouse’s earned income, whichever is less, unless the spouse is disabled or a full-time student, in which case certain income-attribution rules apply.
What are Eligible DFSA Expenses?
Expenses for the following services may be reimbursed from a DFSA, provided they are necessary for the protection and care of the employee’s dependent while the employee works:
- Child day care centers
- Babysitters
- Preschool / Nursery School (not kindergarten)
- Non-educational before or after school care programs
- Adult day care centers
- Family day care centers
- Summer day camp (non- educational)
An employee may claim expenses for services given inside or outside of the home. However, payments are not reimbursable if they are made to certain individuals related to the employee, including a child under age 19, a spouse, the child’s parent, or certain other relatives.
If the service is provided by a day care center that offers care for at least six people (other than residents), the center must comply with all local and state laws and licensing requirements.
Whose Expenses are Eligible for Reimbursement?
An eligible dependent is any dependent who is:
- A child under age 13 who is the employee’s dependent under federal tax
- A child, spouse or parent who is physically or mentally incapable of caring for himself or herself and has the employee’s same place of residence for more than half of the
A dependent generally has to spend at least 8 hours a day in the employee’s household for the dependent’s expenses to be reimbursable.
How Does the DFSA Work?
The DFSA allows an employee to set aside before-tax dollars from the employee’s paycheck to pay for out-of-pocket dependent day care expenses.
To participate in the DFSA, the employee must designate the total amount to contribute each plan year. A portion of the total contribution will be deducted from each paycheck received during the plan year. When an eligible dependent day care expense is incurred, the employee submits a claim for the expense with proper documentation and the employee will be reimbursed tax-free from the account, up to the amount already contributed for the year. Some DFSAs are set up with a debit card for paying expenses.
When making a contribution decision for the year, it is important to conservatively estimate the expenses that will be incurred within the plan year, and any grace period, if permitted by the terms of the plan. According to IRS regulations, any money remaining in a DFSA account at the end of the plan year (and grace period, if any) will be forfeited.
The plan may set a time after the end of the plan year (generally 3 months) for gathering documentation and submitting expenses for reimbursement.
Elections Changes
Because of the special tax advantages that the DFSA provides, the IRS places certain restrictions on contributions to and distributions from the DFSA.
Once deposits are authorized to the DFSA for the plan year, federal rules prohibit an employee from stopping or changing their election until the next plan year, unless the employee experiences a “Change of Status Event” recognized by the plan.
Examples of Change in Status Events
- Change in legal marital status
- Change in number of dependents
- Change in employment status of employee, spouse or dependent that affects eligibility
- Reduction or increase in hours of employment of employee, spouse or that affects eligibility
- Dependent satisfies (or ceases to satisfy) eligibility requirements
Examples of Ineligible Expenses
The IRS decides what is and is not an eligible DFSA expense. For example, the following expenses are not eligible to be reimbursed from a DFSA:
- Non-employment related care (i.e., evening baby-sitting);
- 24-hour nursing home expenses;
- Overnight camp expenses;
- Education expenses for a child in kindergarten, first grade or higher;
- Education programs and camps;
- Childcare expenses that enable a spouse to perform volunteer work;
- Expenses during non-work hours.
All dependent day care expenses must be properly substantiated, consistent with IRS guidelines, and submitted timely to be reimbursed from a DFSA.
Rules to Remember
After an employee elects to participate in the DFSA, contributions are set for the plan year unless the employee experiences a Change of Status Event recognized by the plan.
Claims must be submitted for reimbursement in accordance with the timing set by the plan.
If the employee does not use the money contributed to the DFSA for expenses incurred during the plan year (and grace period, if any), remaining amounts cannot be returned.
Submitting Claims
When submitting a claim for reimbursement from the DFSA, the employee must provide appropriate documentation. An acceptable DFSA claim submission contains a separate, signed and dated claim form for each qualified dependent. The claim form must include a description of services, the dollar amount of the claim, a taxpayer ID number for the provider, the provider’s signature (or receipt), along with supporting documentation. Supporting documentation requires the following elements (cancelled checks are not sufficient): name of qualifying dependent; name and address of provider; date of service; description of service; provider’s taxpayer identification number.
The DFSA is an alternative to the child and dependent care tax credit. An employee may not use the same expenses for both the tax credit and the DFSA.
