What is It?
As the family needs of today's workforce change, you may want to consider offering dependent care assistance to your employees by providing them with a dependent care assistance program (DCAP). Dependent care assistance is the payment of work-related dependent care services. A service is work related if it allows your employee to work and is for a qualifying individual's care. A qualifying individual is:
- A dependent of the taxpayer under the age of 13
- A dependent of the taxpayer who is physically or mentally incapable of caring for herself or himself
- The spouse of the taxpayer, who is physically or mentally incapable of caring for himself or herself
If you choose to offer your employees a DCAP, the IRS furnishes both you and your employees with tax benefits. The IRS allows you to exclude up to $5,000 in dependent care assistance from your employees' gross income (or $2,500 for married couples filing separately). This exclusion reduces your taxable payroll, resulting in a decrease in your payment of Social Security, Medicare, and federal unemployment taxes. In addition, you may be able to deduct the cost of operating a DCAP, depending on the type of dependent care services provided.
Types of Dependent Care Assistance Programs (DCAPS)
A DCAP is a separate written plan for the exclusive benefit of your employees that provides them with dependent care services.
The program typically takes one of three forms:
- The employer reimburses the employee for qualified expenses
- The employer pays third parties for qualified expenses
- The employer operates an on-site day-care facility
IRS Requirements for DCAPS
For you and your employees to be eligible for the DCAP tax deduction, your plan must meet the following requirements:
- The contributions or benefits you provide under the program cannot discriminate in favor of highly compensated employees or their dependents
- You must provide reasonable notification to your employees of the availability and terms of the plan
- The plan shall furnish to an employee, on or before January 31, a written statement that shows the amount you paid or incurred in providing that employee with dependent care assistance (W2s generally suffice)
In addition to the aforementioned requirements, dependent care assistance must satisfy the following nondiscrimination rules:
- You cannot provide shareholders or owners who own more than 5 percent of the stock, capital, or profits with more than 25 percent of the amount you pay or incur under the program
- The average benefits you provide to employees who are not highly compensated must be at least 55 percent of the average benefit you provide to highly compensated employees
Employees Whom You Can Exclude From a DCAP
The IRS allows you to exclude the following employees from coverage under a DCAP: • Employees who are under the age of 21 and have less than one year of service
- Employees who are members of a collective bargaining agreement where there is evidence that the dependent care benefits were the subject of good faith bargaining between the employee's representative and the employer
Tip: For more information on IRS tax treatment of DCAPs, see Section 129 of the Internal Revenue Code.
Other Types of Dependent Care Assistance
In addition to establishing a DCAP, you can also provide your employees with dependent care assistance through a tax-exempt organization, a voluntary employees' beneficiary association, or a dependent care flexible spending account.
If you wish to provide your employees with dependent care without creating a DCAP, you may want to create a tax-exempt organization. You can create a tax-exempt organization that operates a day-care facility by establishing a nonprofit corporation that is a separate entity from your company. For the nonprofit corporation to qualify for tax-exempt status, it must meet the following requirements:
- Substantially all of the care that your organization provides must be for the purpose of enabling individuals to be gainfully employed
- The services that your organization provides must be available to the general public
When you create a tax-exempt organization to operate as a day-care facility, any payments that you make to the organization qualify as charitable contributions and are deductible. In addition, any initial start-up costs that you may incur qualify as a charitable donation and are also deductible.
Voluntary Employees' Beneficiary Association
Another alternative to a DCAP is a voluntary employees' beneficiary association (VEBA). A voluntary employees' beneficiary association may provide for the payment of insurance (life, health, disability), or other benefits to its members. If you provide dependent care assistance through a VEBA, it is exempt from taxation as long as none of the facility's net earnings benefit any private shareholder or other individual. Although the trust is tax exempt, the benefits provided to members under the plan will be included in gross income unless a specific statutory exemption is available.
Dependent Care Flexible Spending Account
A flexible spending account allows your employees to contribute pretax dollars to an account that may later be used to reimburse them for qualified expenses. A dependent care flexible spending account allows you to deduct up to $5,000 each year from your employee's paycheck to fund the account. Your employee's contributions to the account are exempt from federal income and FICA taxes. Under a dependent care flexible spending account, your employees must show you proof of dependent care expenses for you to reimburse the expenses from their account.
Tip: Employees must also provide you with the Social Security numbers of the persons who provide care to their dependents.
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