Question: What are the main issues for married couples to be aware of with respect to the dependent care FSA?
Short Answer: Married couples are generally limited to a $5,000 total dependent care FSA contribution limit between both spouses combined per calendar year. Both spouses generally need to be working for the employee to have daycare expenses that are eligible for dependent care FSA reimbursement. Exceptions apply if the spouse is looking for work, a full-time student, or incapable of self-care.
$5,000 Dependent Care FSA Contribution Limit Combined Between Spouses
Internal Revenue Code §129 sets the annual dependent care FSA contribution limit for married couples filing jointly at $5,000 for both spouses combined. Accordingly, both spouses cannot contribute the full $5,000 amount to each of their employer-sponsored dependent care FSAs. Married couples need to coordinate their dependent care FSA elections with their respective employer offerings to ensure they do not exceed the combined $5,000 maximum.
For married couples filing separately, the annual dependent care FSA contribution limit is $2,500 for each spouse.
A married employee’s dependent care FSA benefit limit is capped at the earned income amount of the lower earning spouse. For example, if the spouse had only $1,000 in annual earned income, the employee’s maximum dependent care FSA benefit would be $1,000 (not the standard $5,000 for filing jointly, $2,500 for filing separately).
ARPA temporarily increased the dependent care FSA limit to $10,500/$5,250 for 2021 only. The limit has since revered back to the standard $5,000/$2,500 cap going forward.
The dependent care FSA limit is not indexed for inflation. The IRS has confirmed on multiple occasions that only an act of Congress can modify the $5,000 statutory limit.
Married Couple Makes Dependent Care FSA Elections in Excess of Combined Limit
Married employees who are unaware of the combined $5,000 dependent care FSA limit will in some cases make elections that exceed the limit. For example, married employees will sometimes both elect $5,000 to their respective employer’s dependent care FSA without understanding the combined limitation that applies.
Where employees come forward with this situation, there are two main considerations to be aware of:
Option to Permit Dependent Care FSA Election Reduction or Revocation on Prospective Basis
The IRS has provided informal guidance stating that employers have the option to permit employees to reduce or revoke their dependent care FSA election on a prospective basis to avoid exceeding the $5,000 combined limit for spouses.That guidance suggests that the employer should ask for some form of documentation from the employee demonstrating that the spouse also elected to contribute to his or her dependent care FSA (causing the potential excess) in order to process the election change.
Employers are not required to permit an employee to change the dependent care FSA election in these circumstances, but most employers would offer the option to reduce or revoke the election where this situation arises.
Potential Excess Amounts Will Be Converted to Taxable Income on Individual Tax Return
If the employee’s and spouse’s dependent care FSA contributions exceed the $5,000 combined limit, the employee will report the excess when filing the individual tax return (Form 1040). As part of the individual tax return, the employee will complete Form 2441. The Form 2441 will compute the amount of any excess dependent care FSA contributions, which must be reported as taxable income on the Form 1040 by writing “DCB” (dependent care benefits) next to Line 1.There is no penalty associated with this process. The excess amounts are merely converted to taxable income. The employee would not lose the excess contribution.
Both Employee and Spouse Must Be Working to Have Eligible Dependent Care FSA Expenses
Employees’ dependent care expenses are eligible for reimbursement under the dependent care FSA only if the expenses are “employment-related,” which means they enable the employee and spouse to be gainfully employed.
If an employee is married, dependent care expenses will qualify as “employment-related” only if:
The employee’s spouse is gainfully employed;
The employee’s spouse is in active search of gainful employment;
The employee’s spouse is a full-time student;or
The employee’s spouse is mentally or physically incapable of self-care with the same principal place of abode as the employee for more than half the year.
Accordingly, married employees should not enroll in the dependent care FSA unless their spouse is working, looking for work, or treated as working because they are a full-time student or not physically or mentally able to care for themselves. For example, employees whose spouse is a stay-at-home parent cannot take advantage of the dependent care FSA.
Unfortunately, there is no basis in any guidance to support the option for employers to rely on the IRS doctrine of mistake to undo a mistaken dependent care FSA election where the employee may not have understood the requirement that expenses be employment-related (i.e., necessary to permit the employee and spouse to work). In that situation, there may be a basis to permit the employee to stop contributing to the dependent care FSA on a prospective basis, but the use-it-or-lose-it rule will require that unreimbursed contributions forfeit at the end of the plan year, following any grace period and/or run-out period.
For more details:
Correcting Erroneous Elections Under the IRS Doctrine of Mistake
Dependent Care FSA Election Changes
Dependent Care FSA Where Spouse is a Full-Time Student
The employee’s spouse is treated as working when going to school as a full-time student. Accordingly, the employee’s dependent care expenses can be employment-related and eligible for dependent care FSA reimbursement where the spouse is not working but meets the definition of a full-time student.
The spouse is a full-time student if enrolled at a school for the number of hours or classes that the school considers full-time. The spouse must be a full-time student for part of each of five calendar months during the year, but the months do not need to be consecutive. High schools, colleges, universities, and technical, trade, and mechanical schools qualify for this purpose. On-the-job training courses, correspondence school, and schools offering courses only though the Internet do not qualify.
Because a married employee’s dependent care FSA benefit limit is capped at the earned income amount of the lower earning spouse, the rules treat a spouse who is a full-time student as having monthly earned income of at least $250 if there is one qualifying person in the home, or at least $500 if there are two or more qualifying individuals (e.g., two or more children under age 13).
Dependent Care FSA Where Spouse is Incapable of Self-Care
The employee’s spouse is treated as working when the spouse is incapable of self-care. Accordingly, the employee’s dependent care expenses can be employment-related and eligible for dependent care FSA reimbursement where the spouse is not working but is not physically or mentally able to care for himself or herself.
The test for whether an individual is incapable of self-care presents a higher bar than a standard disability determination for other purposes, such as for disability benefit purposes. An individual is considered physically or mentally incapable of self-care only if, as a result of a physical or mental defect, the individual is incapable of caring for his or her hygiene or nutritional needs, or requires the full-time attention of another person for the individual’s own safety or the safety of others. The IRS summarizes this standard as “Persons who can’t dress, clean, or feed themselves because of physical or mental problems.”
Regulations further confirm that the inability of the individual to “perform the normal household functions of a homemaker or care for minor children by reason of a physical or mental condition does not of itself establish that the individual is physically or mentally incapable of self-care.”
Because a married employee’s dependent care FSA benefit limit is capped at the earned income amount of the lower earning spouse, the rules treat a spouse who is incapable of self-care as having monthly earned income of at least $250 if there is one qualifying person in the home, or at least $500 if there are two or more qualifying individuals (e.g., two or more children under age 13).
Dependent Care FSA Where Spouse is on Parental Leave
Employees generally will not have eligible dependent care FSA expenses while the employee or spouse is on parental leave because any dependent care expenses will not be for the purpose of enabling the employee and spouse to be gainfully employed (i.e., the expenses will not be employment-related).
For more details: Dependent Care FSA During Parental Leave.
Dependent Care FSA Where Spouse is on Summer Break
In situations where the employee or spouse is not working during the summer (e.g., the employee or spouse is a teacher), the employee generally will not have eligible dependent care FSA expenses because any dependent care expenses will not be for the purpose of enabling the employee and spouse to be gainfully employed (i.e., the expenses will not be employment-related).
For more details: Dependent Care FSA During Summer Break.
Dependent Care FSA Where Spouse is Self-Employed
Self-employment qualifies as gainful employment for dependent care FSA purposes. Therefore, even if the spouse is self-employed, their dependent care expenses can still be eligible employment-related expenses for dependent care FSA reimbursement.
Because a married employee’s dependent care FSA benefit limit is capped at the earned income amount of the lower earning spouse, spouses who are self-employed will need to have earned income through their net earnings from self-employment for the employee to benefit from the dependent care FSA.
For more details: Dependent Care FSA Where Spouse is Self-Employed.
Determining Eligible Dependent Care FSA Expenses
Ultimately, the determination as to whether the employee’s dependent expenses are eligible for reimbursement under the dependent care FSA is an individual income tax issue to be resolved by the employee. Where in question, employees should consult a personal tax advisor for assistance in determining whether their expenses are eligible for dependent care FSA reimbursement.
The dependent care FSA’s third-party administrator will require the employee to certify that the expenses are eligible for reimbursement upon submitting a claim. However, unless the administrator has reason to believe that an expense does not qualify for reimbursement, there will be no further inquiry made by the administrator. The employee is responsible for verifying the eligible expenses on the individual tax return (IRS Forms 1040 and 2441), and if ever raised on audit of the individual tax return by the IRS.
Difficult Dependent Care FSA Eligible Expense Issues
For more details on situations where the qualifying status of dependent care expenses is difficult to determine, see our prior posts:
Dependent Care FSA for Nanny or Family Member Home Childcare
Dependent Care FSA Where Spouse Works from Home or is Self-Employed
Dependent Care FSA When a Child Reaches Age 13
Dependent Care FSA During Maternity Leave
Dependent Care FSA During Summer Break
Dependent Care FSA for Part-Time Work
Dependent Care FSA During Maternity Leave
Health FSA and Dependent Care FSA for Parents
Health FSA and Dependent Care FSA for Special Education
(2)Limitation of exclusion.
(A)In general. The amount which may be excluded under paragraph (1) for dependent care assistance with respect to dependent care services provided during a taxable year shall not exceed $5,000 ($2,500 in the case of a separate return by a married individual).
(b)Earned income limitation.
The amount excluded from the income of an employee under subsection (a) for any taxable year shall not exceed—
(A)in the case of an employee who is not married at the close of such taxable year, the earned income of such employee for such taxable year, or
(B)in the case of an employee who is married at the close of such taxable year, the lesser of—
(i)the earned income of such employee for such taxable year, or
(ii)the earned income of the spouse of such employee for such taxable year.
(2)Special rule for certain spouses.
For purposes of paragraph (1), the provisions of section 21(d)(2) shall apply in determining the earned income of a spouse who is a student or incapable of caring for himself.
(2)Special rule for spouse who is a student or incapable of caring for himself.
In the case of a spouse who is a student or a qualifying individual described in subsection (b)(1)(C) , for purposes of paragraph (1) , such spouse shall be deemed for each month during which such spouse is a full-time student at an educational institution, or is such a qualifying individual, to be gainfully employed and to have earned income of not less than—
(A)$250 if subsection (c)(1) applies for the taxable year, or
(B)$500 if subsection (c)(2) applies for the taxable year.
In the case of any husband and wife, this paragraph shall apply with respect to only one spouse for any one month.
Working or Looking for Work
To be work related, your expenses must allow you to work or look for work. If you are married, generally both you and your spouse must work or look for work. One spouse is treated as working during any month he or she is a full-time student or isn't physically or mentally able to care for himself or herself.
§ 125, § 129 – Dependent Care Expense Reimbursement Under a Cafeteria Plan The husband of a married couple works at Corporation A and his wife works at Corporation B. Corporation A and Corporation B each maintain a calendar-year cafeteria plan that allows eligible employees to elect to have up to $5,000 deducted from pay and contributed to a dependent care reimbursement account under a cafeteria plan. At open enrollment, both the husband and wife elect to have $5,000 deducted from pay to be contributed to the dependent care reimbursement account under the applicable cafeteria plan. After the start of the calendar year, the husband and wife realize that they have elected to have too much contributed to a dependent care reimbursement account. May one spouse (either the husband or wife) ask the applicable employer to revoke that spouse’s election to have $5,000 deducted from pay to be contributed to the dependent care reimbursement account?
Proposed Response: One spouse may ask the applicable employer to revoke the election, if that spouse documents that each of the spouse’s elected to have $5,000 deducted from pay to be contributed to the dependent care reimbursement account. This is permitted because the spouses made a mistake of fact regarding the maximum amount that may be reimbursed under Code § 129. Also, allowing an employer to cancel the election assures the proper FICA and FUTA taxes are imposed. Although a spouse’s employer may allow the spouse to cancel such an election, the employer is not required to cancel the election.
IRS Response: The Service representative agrees with the proposed response.
If line 26 is more than zero, you have taxable dependent care benefits. Include this amount in the total on Form 1040 or 1040-SR, line 1; or Form 1040-NR, line 1a, whichever applies. Enter “DCB” in the space to the left of that line to show that taxable dependent care benefits are included in that amount.
Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues.This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship. Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).
The article provides comprehensive insights into the complexities of the Dependent Care Flexible Spending Account (FSA) for married couples. Here's a breakdown of the concepts covered:
- For Married Couples: The combined limit for both spouses is $5,000 per calendar year.
- Married Filing Separately: Each spouse has an annual limit of $2,500.
Limitation Based on Earned Income:
- The FSA benefit is capped at the earned income of the lower-earning spouse. For instance, if one spouse's income is $1,000, the maximum FSA benefit becomes $1,000 instead of the usual $5,000 for jointly filing couples.
Temporary Adjustments and Non-Indexation:
- The ARPA temporarily increased the limit to $10,500/$5,250 for 2021, but it reverted to the standard $5,000/$2,500 afterward.
- The $5,000 limit isn't adjusted for inflation without a specific act of Congress.
- If contributions exceed the $5,000 limit, the excess is considered taxable income. There's no penalty, but it gets added to taxable income on Form 1040.
Eligibility Criteria for Dependent Care Expenses:
- Eligible expenses must be "employment-related," facilitating both spouses to work or seek employment.
- Eligibility conditions include the spouse being employed, seeking employment, a full-time student, or incapable of self-care.
Spouse's Status and FSA Eligibility:
- Full-Time Student: If the spouse is a full-time student, their status can qualify as gainful employment.
- Incapable of Self-Care: When the spouse is incapable of self-care due to physical or mental reasons, their expenses may qualify.
- Parental Leave: Dependent care expenses during parental leave may not qualify as employment-related.
- Summer Break or Self-Employment: Situations where neither the employee nor the spouse is working might not qualify for FSA reimbursement, except for self-employment scenarios.
Determining Eligible Expenses:
- The responsibility to ensure expense eligibility lies with the employee, who needs to verify it on IRS Forms 1040 and 2441.
- Third-party administrators may require certification, but the onus remains on the employee during an IRS audit.
Difficult Expense Determinations:
- Several complex situations might arise, such as childcare by family members, when a child reaches 13, or during maternity leave, warranting careful consideration.
Legal Considerations and Guidance:
- The IRS allows employers the option to permit changes to FSA elections if spouses inadvertently exceed contribution limits, given proper documentation.
- However, mistakes in understanding the employment-related nature of expenses might not provide a basis for reversing FSA contributions.
IRS Citations and Publications:
- Various IRS sections (e.g., IRC §129) and IRS publications (e.g., Publication 503) outline the regulations and qualifications for FSA reimbursements.
This in-depth analysis highlights the nuances of dependent care FSAs for married couples, emphasizing contribution limits, eligibility criteria, and potential tax implications. Always advisable: consulting a tax advisor for specific scenarios or complex expense determinations.