The IRS issued Notice 2021-26 to address the tax treatment of dependent care benefits provided through a Section 125 Cafeteria Plan for tax years ending in 2021 and 2022. The IRS clarified that amounts attributable to carryover and extended grace period relief for a dependent care assistance program (DCAP) Flexible Spending Account generally are not taxable.
Specifically, if these 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. They will also generally not be taken into account for purposes of applying the exclusion limits of Internal Revenue Code Section 129.
This guidance is only applicable to employers who offer a DCAP and adopt the carryover/rollover or the extended grace period. As a reminder, employers are not required to adopt the carryover or extended grace period, which were provided as COVID-19 relief under the Consolidated Appropriations Act (CAA). For a refresher on the rules, see this IRS webpage.
Please see bulletin below for more information on the new tax guidance, including IRS examples.
If you have questions or need help, please contact one of our benefit consultants.