Dependent Care FSA: A Tax Benefit Program for Workers

You may have a loved one living in your home who does not have the ability to care for themselves. In many cases, employees must pay for much-needed care for a dependent relative so that they can continue to work. If this situation sounds familiar, you may qualify for a little-known, but significant tax benefit.

The Dependent Care Assistance Program is a provision of the Internal Revenue Code, the nation's tax law. It allows you to set aside pre-tax money to use toward qualifying services that your dependent relative needs. For instance, you may have a child with disabilities or a spouse or elder who relies on certain care services.

Dependent Care Flexible Spending Accounts

The Dependent Care Assistance Program, or DCAP, operates much like Health Reimbursement Accounts. Employers can put up to $5,000 of an employee's pre-tax income into a Dependent Care flexible spending account. The employee can then use those funds to pay for eligible dependent care services for their relative. This can include, for example, child or adult daycare or community-based care for a dependent living with disabilities.

Most employers will not offer to pay for DCAP services on top of their employees' annual salaries. Instead, they typically allow their employees to opt into the program and decide how much they would like to contribute to their DCAP account, much like a 401(k).

For example, let's say an employee's regular yearly salary is $50,000 before taxes. The employee can elect to make a dependent care FSA contribution of up to $5,000 in a plan year (as of 2024). With $5,000 moved into a DCAP account, they would take home $45,000.

They can then spend the $5,000 on care for their dependent with special needs. The dependent may be their child or another live-in member of the family who is unable to care for themselves, such as a senior parent. In addition, the money you choose to contribute to the FSA does not count as taxable income. Unfortunately, employers have to elect to set up a DCAP; employees cannot create one on their own.

What Dependent Care Expenses Are Eligible?

Supporting a loved one with a disability can mean higher financial expenses. To raise a child with a disability to age 18, for example, the U.S. Department of Agriculture cites a cost of more than $1 million. A 2020 report calculated that households in which an adult has a disability that limits their ability to work must make, on average, 28 percent more income per year than those with no disabled family members to achieve the same standard of living.

You can use DCAP funds to cover a variety of services for a dependent with special needs. This may include the following:

• payments to caregivers
• after-school care
• care in a dependent care center
• transportation provided by a care provider
• household services for the well-being and protection of the dependent

However, keep in mind that DCAP funds cannot go toward paying for most school expenses, food and clothing, overnight camp, or 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.

DCAP FSA Benefits – and Caveats

Workers interested in establishing these kinds of accounts for dependent care services should take note of a few important points. For one, you do have to use it or lose it, so to speak; that is, you cannot carry over your DCAP FSA funds to the following tax year.

Be sure to save all relevant receipts and other documentation. The Internal Revenue Service (IRS) will require information on the specific services you have paid for with the money you contributed to your DCAP account.

Employees who participate in a DCAP should also be aware that the funds placed into this type of account reduce the Child and Dependent Care Tax Credit that they could claim on their personal income tax return.

In addition, employees in low tax brackets may not benefit as much from placing pre-tax dollars into a DCAP account compared with employees in higher tax brackets, who could see substantial gains if their use of a DCAP account moves them to a lower tax bracket.

Work With a Special Needs Planner

You should discuss DCAP with a local special needs planner prior to funding an account. They can walk you through all the ins and outs of the Dependent Care Assistance Program.

These experts also can identify other resources that could help support a dependent loved one living with a disability. Find a qualified special needs planning attorney near you today to learn more.

For additional reading on programs and options that help support people with disabilities, check out the following foundational articles:

• What Is an ABLE Account? An Introduction
• An Introduction to Supplemental Security Income (SSI)
• The Basics of Social Security Disability Insurance (SSDI)
• What to Know Before Beginning Special Needs Planning