By: HUB’s EB Compliance Team

Last month HUB wrote about Dependent Care Assistance Programs (“DCAP”), which are sometimes referred to as Dependent Care Flexible Spending Accounts (“DCFSA”). This month, our series continues with an overview of mid-year election changes to these accounts.

Irrevocable Elections

While DCAPs provide significant tax benefits, they do so at a cost — participant benefit elections are generally irrevocable for the next 12 months. This effectively means that once an election is made, it cannot be changed until the next open enrollment period. The exception to this rule is when the employee experiences a qualifying event (sometimes referred to as a qualifying life event, or “QLE”) as defined by the plan. Qualifying events are specific events that allow individuals to make changes to their existing elections outside of open enrollment.

Qualifying Events

The IRS rules governing qualifying events can be complicated, and their applicability to cafeteria plan benefits depends on the specific facts. Additionally, experiencing a qualifying event does not necessarily mean an employee can change all of their elections. For example, certain events only allow for specific changes that are consistent with the actual event. If a dependent child reaches age 26 and thus, loses eligibility for their parent’s plan, this change in the number of dependents allows the child who is no longer eligible to be dropped from coverage. This change would not allow the parent to simultaneously add a different eligible child to the plan, unless that child experienced a separate qualifying event. Likewise, an employee who divorces their spouse can remove the former spouse from their plans but not change other plan elections.

DCAP Qualifying Events

DCAPs are inherently unique compared to other cafeteria plan benefits partly because they are not considered health plans under ERISA, unlike a healthcare FSA or an HRA plan. Therefore, the qualifying events applicable to DCAPs are related specifically to the benefits provided. Below is a summary of certain qualifying events that can apply to DCAPs that do not apply to other benefits.

  • Changes in care providers (in-center or home-based)
  • Changes in care providers because someone has agreed to watch the child for free
  • Changes in the employee’s or spouse’s work schedule, which change the parents’ childcare needs
  • A child of divorced parents changes residences.

The common theme among these qualifying life events is an underlying change to childcare, which impacts the childcare needs of the employee. In allowing these changes, the regulations recognize that childcare needs change and evolve and thus allow for a certain degree of flexibility.

These are just a few examples of the potential qualifying events that plans can choose to allow. However, they are optional, and plan sponsors have discretion to decide which events they allow. To be permissible life events under the plan, they must be included in the employer’s DCAP plan document and summary plan description.

Allowable Changes

Now that we know which events can allow DCAP plan elections to be changed, we will pivot to focus on the actual changes that can be made. With DCAPs, there are effectively only two possible changes — increasing or decreasing the contribution election.

Increasing elections is the easier of the two changes to understand. Imagine an employee elects to contribute $3,000 during open enrollment. During the plan year, their spouse’s work schedule changes, which in turn changes the employee’s childcare needs. This event would allow the employee to increase their election to a higher amount.

Reducing elections under a DCAP is more complex since the amount contributed as of the change effectively acts as a floor to how much the elections can actually be reduced. Imagine similar facts to those above, except here the employee elects to contribute $5,000 to their DCAP at the beginning of the plan year. The employee’s spouse’s work schedule changes, which again changes the employee’s childcare needs. However, this schedule change might actually reduce their childcare needs rather than increasing them.

If the employee has already contributed $2,500 as of the qualifying event, they can still decrease their elections but not below the $2,500 threshold. This is because DCAPs do not allow for taxable refunds of contributions. If the employee sought to reduce their election to $2,000, they would not receive the excess $500 returned as taxable wages. This policy is consistent with the overall bargain between the Internal Revenue Service (“IRS”) and taxpayers regarding pretax deductions.

Impossibility and Refunds

Employees sometimes mistakenly believe that their DCAP contributions can be refunded if they deem their DCAP funds impossible to use. This was a very common misconception during the Covid-19 pandemic and still continues today, particularly with regard to summer camps.

For example, an employee elects to contribute an amount during open enrollment in order to pay for day camp for their child during the summer. The employee doesn’t register the child on time, and the camp is now completely filled. Rather than pursuing another solution, the employee makes alternative arrangements that do not qualify as eligible DCAP expenses and thus, considers the funds impossible to use.

The change in childcare from a specific camp to alternative arrangements could potentially be a qualifying event. While this event may allow the employee to reduce their existing DCAP election, it is not actually impossible for the employee to use the funds. Even if it were technically impossible to spend the account, this situation still would not allow the employee to receive a refund of the contributions they have already made.

Conclusion

This article is designed to provide an introductory overview of the DCAP qualifying events, while highlighting their practical application. HUB's series on DCAPs will continue next month by highlighting nondiscrimination testing for DCAPs.

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.