The American Rescue Plan Act (ARPA) was signed into law on March 11, 2021, offering many pandemic relief benefits to individuals and businesses. One big highlight for families is around Dependent Care Flexible Spending Accounts (DC-FSA). The ARPA raised pre-tax contribution limits for DC-FSAs and increased the value of the dependent care tax credit for 2021.
What is a Dependent Care FSA?
A Dependent Care Flexible Spending Account (DC-FSA) is a benefits account that individuals can use to save pre-tax dollars for eligible dependent care expenses. Common uses for a DC-FSA are to pay for childcare such as babysitters and before/after school programs, summer camps and expenses for a spouse who is physically or mentally disabled. Annual contribution limits for DC-FSAs are set by the IRS each year.
What changed for DC-FSAs?
New Limits
The previous DC-FSA 2021 contribution limits were $5,000 for married couples filing jointly and single taxpayers, and $2,500 for married couples filing separately. With the ARPA, the limits are now $10,500 for couples filing jointly and single taxpayers and $5,250 for married filing separately.
Employer plans must be amended for employees to take advantage of the increased limits.
Interaction with Dependent Care Credit
The dependent care tax credit also has increased limits under the new law. For 2021, the maximum amount of expenses eligible for credit is $8,000 for one qualifying individual and $16,000 for two or more qualifying individuals (up from $3,000 and $6,000 in prior years).
The credit is now equal to up to 50% of expenses for taxpayers with AGI of $125,000 or less and decreases to 20% as income increases. That 20% minimum will decrease further for taxpayers with AGI over $400,000. In prior years, the maximum was only 35% for taxpayers with AGI of $15,000 and capped out at a 20% minimum for everyone.
Employees should consider their specific circumstances to determine the combination of the DC-FSA deferral and the dependent care credit that is most advantageous.
Rollovers
The IRS and Congress also provided DC-FSA relief with the Consolidated Appropriations Act (CAA) signed into law at the end of 2020, and IRS Notice 2021-15 issued in March 2021. The CAA allows employers that offer DC-FSAs to allow participants to rollover unused funds from 2020 to 2021 and funds from 2021 to 2022. This gives participants a larger window of time to submit expenses to utilize those funds instead of losing them since COVID-19 quarantines and shutdowns may have caused a lack of childcare expenses in 2020.
Age Out Extension
IRS Notice 2021-15 allows employers to extend the DC-FSA coverage period for dependents who turn 13 years old during the COVID-19 public health emergency timeframe. These dependents would typically ‘age out’ and therefore any expenses for them would not be eligible for reimbursement through the DC-FSA. The limiting age for 2021 is now set at 14 years old, but the expenses can only be reimbursed from unspent 2020 funds.
What should employers do?
Employers must share any plan amendments created by the ARPA, CAA, and/or IRS Notice 2021-15 and communicate to participants that they can make mid-year DC-FSA contribution changes.
Our advisors are closely following COVID-19 relief efforts and will continue to publish insights to keep you informed. Visit our COVID-19 Resource Center for more resources. To discuss questions around DC-FSAs or recovery options, contact an Anders advisor below.
Erin E. Prest is a contributor to this post.
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