IRS clarifies changes to the rules regarding dependent care programs

Recent updates to IRS guidance has clarified taxability questions surrounding dependent care assistance programs for 2021 and 2022. Two new federal laws—the Consolidated Appropriations Act (CAA) and the American Rescue Plan Act (ARPA)—have created new opportunities for participants in flexible spending accounts (FSA).  IRS Notice 2021-26 clarifies for taxpayers that if dependent care benefits would have been excluded from income if used during taxable year 2020 (or 2021, if applicable), these benefits will remain excludible from gross income and are not considered wages of the employee for 2021 and 2022.  Generally, amounts attributable to FSA carryovers or an extended period for incurring FSA claims are not taxable.

Other parts of the new clarification include:

  • Employers can amend their FSA plans to allow for unused expenses in 2020 and 2021 to have a grace period of 12 months after the year-end, versus the 2 ½ month grace period already allowed for in most FSA plans.
  • Allocations to a dependent care program can be amended mid-year for a plan year ending in 2021. This includes enrolling, dis-enrolling, increasing or decreasing contribution amounts.

ShindelRock tax professionals are advising filers to closely examine 2020 income tax returns that have taxable unused dependent care benefits.  We are waiting for clarity on the possible need to amend federal tax returns already filed as well as state/city tax returns, if applicable.  To find out if your tax return is affected, contact a ShindelRock tax professional.