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A Better Partnership


Jun 2006
June 05, 2006

IRS Proposed Dependent Care Regulations Issued

The Internal Revenue Service (“IRS”) recently published proposed regulations concerning eligible expenses under dependent care assistance programs (“DCAPs”), including dependent care flexible spending arrangements (FSAs) and the dependent care tax credit. These proposed regulations update and clarify existing IRS guidance on dependent care expenses and offer a number of examples of eligible expenses. Major proposed updates include:

  • Definition of “Qualifying Individual.” An expense is reimbursable under a DCAP or dependent care FSA only if it is incurred in connection with the care of a qualifying individual. A “qualifying individual” is defined as (i) an employee’s qualifying child who is under age 13, or (ii) an employee’s spouse or a tax dependent who is physically or mentally incapable of self-care and has the same principal place of abode as the employee for more than half the year. This definition differs from previous guidance in that it requires that a qualifying individual have the same principal place of abode as the employee for more than half of the year rather than live in the same household. The status of a qualifying individual is determined on a daily basis. If a dependent child turns 13 on June 1, the dependent no longer qualifies on that day.

  • Children of Divorced Parents. Under the proposed regulations, only the parent with whom a child shares the same principal place of abode for the greater portion of the year may seek reimbursement from a DCAP for the care of the child. This rule applies even if the non-custodial parent may claim the dependency exemption for the child for that year.

  • Payments to Related Individuals. The proposed regulations revise the rules on when dependent care expenses paid to family members are reimbursable. Payments for dependent care are not covered if the services are provided by the employee’s tax dependents, employee’s children under the age of 19, employee’s spouse, or the parents of the qualifying individual. Payments to relatives who are not the employee’s dependents may now be reimbursed if they do not fall into one of the four listed categories.

  • Allocation for Part-Time Employees and Temporary Absences. The proposed regulations provide new rules for part-time employees and employees on temporary absence. A part-time employee must allocate dependent care expenses between days worked and days not worked; however, if dependent care expenses are calculated on a weekly, monthly, or annual basis (i.e., not daily or hourly), the part-time employee does not need to allocate expenses. Additionally, an employee who is temporarily absent from work (such as for vacation or minor illness) need not allocate dependent care expenses if those expenses are paid on a weekly, monthly or annual basis.

  • Specific Expenses. The proposed regulations provide a number of specific examples regarding expenses that qualify as reimbursable dependent care expenses:

    • School. Expenses for pre-school or similar programs for children below the kindergarten level. Tuition expenses for a child in kindergarten or a higher grade are not reimbursable; however, expenses for before-school or after-school care of a child in kindergarten or higher may qualify as a reimbursable expense.

    • Day Camps. The cost of a day camp or similar program even if the camp specializes in a particular activity (such as basketball or computers). Reimbursement for overnight camps, however, is not permissible.

    • Transportation. The cost of transportation paid to a dependent care provider.

    • Room and Board. The cost of providing room and board for a caregiver.

    • Indirect Expenses. Expenses that are related to the care of a qualifying individual if the employee is required to pay the expenses to obtain the related care. These might include application fees, agency fees, or deposits to obtain the services of a caregiver.

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The IRS is currently accepting comments on these proposed regulations until August 22, 2006. Although the proposed regulations are not effective until approved in final form by the IRS, they may be relied upon as authoritative guidance until final regulations are published. We suggest that employers review their DCAP program and procedures. Please contact us if you have any questions regarding these new rules and their impact on DCAPs and dependent care FSAs.

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Sue Conway is a partner in the Grand Rapids office of Warner Norcross & Judd LLP. Sue concentrates her practice in two specialty areas: employee benefits and real estate. She has counseled employers for over 18 years in the design and administration of group health, disability, Section 125 cafeteria and other health and fringe benefit plans, including new consumer directed health plans such as health reimbursement arrangements (HRA’s) and health savings accounts (HSA’s). Sue may be reached at 616.752.2153. Warner Norcross & Judd is a full-service law firm with offices in Grand Rapids, Holland, Metro Detroit and Muskegon. Because each business situation is different, this information is intended for general information purposes only and is not intended to provide legal advice.

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