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Workers who must pay for the care of a dependent relative, including a child with special needs, so that they can continue to work can get a significant tax benefit under a little-known provision of the Internal Revenue Code, the nation's tax law, known as the Dependent Care Assistance Program (DCAP).
The program works much like Health Reimbursement Accounts: employers can put up to $5,000 of an employee's pre-tax income into a DCAP account and employees can then use those funds to pay for a dependent relative's care, including child care or community based care for children with special needs. Most employers will not offer to pay for DCAP services on top of their employees' annual salaries, but instead allow their employees to choose to participate in the program and to determine how much they would like to contribute to their DCAP account, much as they do with like a 401(k). For example, if an employee's regular yearly salary is $50,000 before taxes, she could elect to place $5,000 of those pre-tax dollars into a DCAP account and she would take home $45,000. As long as the $5,000 is spent on care for her dependent children (or another dependent relative, such as an elderly parent), the income will not be taxed. Unfortunately, employers have to elect to set up a DCAP - employees cannot create one on their own.
DCAP funds can be used to provide a variety of services to a person with special needs, including payments to caregivers, after-school care, care in a dependent care center, transportation provided by a care provider and household services for the well-being and protection of the person with special needs. However, DCAP funds cannot be used to pay for most school expenses, food and clothing, overnight camp, and services provided by an employee's spouse or dependent relative. In addition, the covered services must be necessary to allow the employee to continue to work.
Employees who participate in a DCAP should be aware that the funds placed into an account reduce the Child and Dependent Care Tax Credit that they could claim on their personal income tax return. Furthermore, employees in low tax brackets may not benefit as much from placing pre-tax dollars into a DCAP account compared to employees in higher tax brackets, who could see substantial gains if their use of a DCAP account moves them to a lower tax bracket.
You should discuss DCAP with your special needs planner prior to funding an account to learn the pros and cons of the system.