IRS Provides Guidance on the Taxation of Dependent Care Benefits Available Pursuant to an Extended Claims Period or Carryover

On May 10, 2021, the IRS published Notice 2021-26, Taxation of Dependent Care Benefits Available Pursuant to an Extended Claims Period or Carryover. This guidance clarifies previous Notice 2021-15, which stated that unused DCAP amounts carried over from prior years or made available during an extended period for incurring claims are not considered in determining the annual limit applicable for the following year. You can find our previous Compliance Corner article on Notice 2021-15 here.

The new guidance clarifies Notice 2021-15 by stating that DCAP benefits that would have been excluded from income if used during the taxable year ending in 2020 or 2021, as applicable, remain eligible for exclusion from the participant’s gross income and are disregarded for purposes of application of the limits for the subsequent taxable years of the employee when they are carried over from a plan year ending in 2020 or 2021 or permitted to be used pursuant to an extended claims period.

The guidance includes several examples, such as the following:

An employee is covered by a calendar year § 125 cafeteria plan that offers a DCAP benefit. The employee elects no DCAP benefits for the 2019 plan year. The employee elects to contribute $5,000 for DCAP benefits for the 2020 plan year but incurs no dependent care expenses during the plan year. Pursuant to § 214 of the Act [CAA], the § 125 cafeteria plan allows the employee to carry over the unused $5,000 of DCAP benefits to the 2021 plan year. The employee elects to contribute $10,500 for DCAP benefits for the 2021 plan year.

The employee incurs $15,500 in dependent care expenses in 2021 and is reimbursed $15,500 by the DCAP. The $15,500 is excluded from the employee’s gross income and wages because $10,500 is excluded as 2021 benefits and the remaining $5,000 is attributable to a carryover permitted under § 214 of the Act.

Employers should be aware of the tax treatment of carryover and extended grace period amounts if they elected to provide them in their cafeteria plans.

Notice 2021-26 »