What is a DCAP?

By: HUB’s EB Compliance Team

Under U.S. tax code (“Code”) §129(d)(1), a “dependent care assistance program” (or DCAP) is defined as “a separate written plan of an employer for the exclusive benefit of [its] employees to provide such employees with dependent care assistance.”

Code §129(a)(2) permits a taxpayer to exclude up to $5,000 from gross income for amounts paid or incurred by his or her employer for dependent care assistance pursuant to a DCAP.

Most commonly, employees participate in DCAPs by contributing a portion of their pay under a cafeteria plan. DCAPs can fall into several highly regulated plan categories:

• they are dependent care assistance programs subject to certain Code requirements;
• they are flexible spending arrangements subject to additional requirements contained in IRS regulations;
• they can be (but rarely are) employee welfare benefit plans subject to the federal Employee Retirement Income Security Act (“ERISA”); and
• a DCAP offered under a cafeteria plan is subject to Code requirements affecting cafeteria plans.

DCAPs Are Subject to Code §129

Code §129 prescribes a host of legal requirements for DCAPs. For instance, a DCAP requires a written plan document, but a DCAP need not have funds set aside in a trust. If a DCAP fails to meet any of the Code §129(d) requirements, then highly compensated employees (HCEs) participating in the DCAP will lose their income exclusion under Code §129, but non-highly compensated employees (non-HCEs) will still retain the exclusion. In other words, DCAP benefits will be taxable to HCEs, but not to non-HCEs. In addition, a plan that reimburses ineligible expenses (e.g., without obtaining appropriate claims substantiation) may risk disqualification (thereby affecting all participants).

DCAPs That Are Flexible Spending Arrangements Are Subject to Most IRS Rules on FSAs

Most DCAPs are flexible spending arrangements or FSAs. An FSA is a program that provides employees with coverage under which specific, incurred dependent care expenses may be reimbursed. A DCAP FSA may have reasonable conditions on reimbursements, such as the requirement to fill out a specific forms. Under the applicable IRS rules, all expenses reimbursed by the DCAP FSA must be substantiated. Additionally, the typical maximum amount of DCAP reimbursement for a plan year is equal to 100% of the annual contribution.

Period of Coverage and Contributions

A DCAP “period of coverage” is the period when reimbursable expenses can be incurred. The period of coverage under a DCAP must be 12 months, with certain exceptions, such as for a short plan year in the year the DCAP is established. Expenses incurred before or after the period of coverage generally may not be reimbursed from contributions and benefits for that coverage period. In addition, elections to contribute generally cannot be changed during the period of coverage except as permitted under IRS rules.

Under 2007 proposed regulations, the interval for employee contributions must be specified in the plan and must be uniform for all participants. Thus, it appears that a plan document may not permit employees to vary how they contribute to the DCAP (other than due to changes in status), nor should an employer and employee agree to accelerated employee contributions. By contrast, the regulations would not appear to prohibit arrangements involving unequal contribution amounts that apply on a uniform basis-e.g., a plan covering teachers could take contributions for 12 months of benefits over a 9-month period for all teachers.

Use-or-Lose Rule

A cafeteria plan generally cannot permit employees to carry over unused contributions under a DCAP from one year to another. However, cafeteria plans may allow participants to access unused amounts remaining in their accounts at the end of a plan year to pay or reimburse expenses for qualified benefits (such as DCAP expenses) incurred during a grace period of up to two months and 15 days after the close of the plan year. The grace period is optional and must be provided for in the plan documents.

Run-Out Period

Most DCAPs provide a period of time after the end of the plan year (or grace period), known as a “run- out period,” during which claims incurred prior to the end of the plan year (or prior to the end of the grace period, if applicable) can be submitted. For example, an expense incurred on or near the end of the plan year may not be invoiced until after the plan year is over. As a result, plans allow some additional time to submit these expenses. Common run-out periods for current employees are 30 days, 60 days, or 90 days after the end of the plan year (or the end of the grace period, if applicable).

Plan documents should also specify how long the run-out period is after an employee terminates employment. Some employers also require that claims be turned in within 30, 60, or 90 days after termination of employment. Other employers apply the same deadline to terminated and current employees.

Reimbursement of Claims

Technically there is no requirement that claims be reimbursed at least monthly . For administrative convenience, however, many employers reimburse claims monthly, or when the total amount of the claims reaches a reasonable minimum amount (e.g., $50). This is especially true where an employer maintains both a DCAP and a health FSA (the health FSA being subject to the monthly reimbursement requirement).

DCAPs Rarely Are Employee Welfare Benefit Plans Subject to ERISA

A DCAP that reimburses employees for dependent care expenses (or that pays the providers of dependent care services directly) generally is not an ERISA welfare plan. In contrast, employer-sponsored on-site day-care centers are ERISA welfare plans.

An otherwise ERISA-exempt DCAP can become an ERISA plan in two unlikely situations. First, a DCAP could become an ERISA plan if participating employees are required to choose a specific dependent care provider. In that case, the law views the DCAP as providing a day-care center, like an employer-sponsored on-site daycare center. Second, a DCAP could become an ERISA plan if reimbursements are provided for other benefits listed in the ERISA plan definition-e.g., for the purpose of assisting persons who are disabled (thus qualifying as disability benefits) or for nursing services provided in a home-based or other non-institutional setting (thus qualifying as medical benefits). These are rare and should not apply in most circumstances.

Any DCAP that is an ERISA plan will need to comply with ERISA’s reporting and disclosure, fiduciary, and other requirements.

If you have any questions, please contact your HUB Advisor. View more compliance articles in our Compliance Directory.

NOTICE OF DISCLAIMER

Neither Hub International Limited nor any of its affiliated companies is a law or accounting firm, and therefore they cannot provide legal or tax advice. The information herein is provided for general information only and is not intended to constitute legal or tax advice as to an organization’s or individual’s specific circumstances. It is based on Hub International’s understanding of the law as it exists on the date of this publication. Subsequent developments may result in this information becoming outdated or incorrect and Hub International does not have an obligation to update this information. You should consult an attorney, accountant, or other legal or tax professional regarding the application of the general information provided here to your organization’s specific situation in light of your or your organization’s particular needs.