A dependent care flexible spending account (FSA) is a benefit small businesses can provide their employees. Dependent care FSAs (DCFSA) can increase employee loyalty by helping your team manage the expenses of caring for dependents. Another draw of this particular benefit is that it helps your employees reduce their tax liability.
We’ll explain what dependent care FSAs entail and how they reduce employee turnover to help small business owners decide if this benefit is right for their organization.
You’re not required to provide your employees with an FSA. However, SHRM reports that 63 percent of businesses offer this employee benefit to improve the employee experience and make a difference in their employees’ lives.
A dependent care FSA is part of a broader benefits category known as flexible spending accounts. FSAs are considered a health and wellness benefit and are part of an overall employee compensation package. They let employees set aside money on a pre-tax basis to help pay for out-of-pocket healthcare expenses. They are only available through employers.
There are two primary FSA categories:
A dependent care FSA is designed for workforce members responsible for dependent care. Specifically, DCFSAs can help ease the financial burden of the “sandwich generation” — employees responsible for children under 18 and aging adults. According to the Pew Research Center, more than half of U.S. adults in their 40s are in this demographic. And according to LendingTree research, American adults spend up to 29 percent of their income on child care.
A DCFSA is a job perk that can improve morale. It can also help prevent employee tardiness and workplace absenteeism, which in turn can increase productivity. With this benefit, your employees’ family care issues are less likely to interfere with their ability to show up on time or distract them at work.
Employees with a dependent care FSA have a pre-tax percentage of their wages automatically deducted from each paycheck. The DCSFA annual maximum contribution limits are $5,000 per household, or $2,500 if married filing separately.
Employees can use money in their DCFSA to pay for IRS-eligible expenses associated with care for dependents in the following categories:
Employees can either pay for these services using a debit card or pay out of pocket and apply for reimbursement, which involves paperwork.
Reimbursement-eligible services make it possible for the employee to work and pay for dependent care. Here are some examples of reimbursement-eligible services:
But not everything is eligible for reimbursement. Ineligible services include the following:
Qualifying dependents are clearly defined in DCFSA regulations. To qualify, an employee’s dependent must meet the following criteria:
Employee contributions to DCFSAs have specific regulations. Keep the following in mind if you’re considering implementing or using a DCFSA:
One downside to FSAs is that they have a use-it-or-lose-it stipulation. So if an employee doesn’t spend all of the money in the account during the plan year, they forfeit the remainder. Consequently, this program is best suited for employees with predictable care expenses.
Here are two examples to illustrate this point:
Employers can provide a partial solution for the use-it-or-lose-it dilemma by allowing employees a grace period of 2.5 months after the plan year’s end for spending what’s in the account. The funds are forfeited if they are not spent in that grace period.
Typically, there are limitations on what the IRS will tolerate for FSA programs to qualify for tax benefits. Rules were softened in 2020 because of the pandemic, and some less stringent rules remain today. For example, midyear changes are now allowed, but only if the employer agrees to administer the changes.
As far as the IRS is concerned, employees can drop or switch plans at any time of the year. The number of times your employees can do this is entirely up to you as the employer.
DCFSAs and healthcare FSAs (HFSAs) are similar. Both share the features of pre-tax deposits, limits on contribution amounts, use-it-or-lose-it provisions, and grace period allowances.
However, employees can use a healthcare FSA to pay expenses that health insurance does not cover, including deductibles for health insurance and co-payments for medical treatments.
Employers can set up both dependent care and healthcare FSA benefits for employees. However, you must inform employees that they must enroll in both plans separately. Many employees don’t realize this, so they could miss out on the benefits.
Also, many people mistakenly assume that a dependent care FSA can help pay for dependents’ medical expenses. However, that is not the case, since the two types of accounts cannot be commingled.
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That depends on whether your employees will take advantage of this benefit. If your employees want a dependent care FSA, there are many benefits to providing it, including the following:
The child care tax credit is another way to help with child care expenses. The credit is based on how much money someone spends on child care. With this credit, you can claim a total of $3,000 per child (for one or two children), and claimed expenses are deducted from taxable income.
The child care tax credit offers the following benefits:
When deciding whether to offer a DCFSA, consider the following questions:
Offering comprehensive benefits like a dependent care FSA can give your company an edge in the hiring process. Bright, talented employees want workplaces with excellent benefits and a company culture that prioritizes a positive work-life balance.
Workers who receive assistance with child care and healthcare costs will likely be grateful and loyal to your company. Offering benefits that meet the needs of most of your employees can be a smart strategy for your small business. The return on investment could be significant.
Jamie Johnson contributed to this article.