IRS issues guidance on taxability of dependent care assistance

The Internal Revenue Service has clarified that dependent care benefits that are attributable to carryovers or have an extended period for incurring claims generally are not taxable this year or the next.

Notice 2021-26 says that if these dependent care benefits would have been excluded from income if used during taxable year 2020 (or 2021, if applicable), they will remain excludable from gross income and are not considered wages of the employee for 2021 and 2022.

The guidance also illustrates the interaction of this standard with the one-year increase in the exclusion for employer-provided dependent care benefits, from $5,000 to $10,500, for the 2021 taxable year under the American Rescue Plan Act.

Carryovers of unused dependent care assistance program amounts generally are not permitted, although there is a grace period. Recent coronavirus-related legislation (the Taxpayer Certainty and Disaster Tax Relief Act of 2020) allowed employers to amend their plans to permit the carryover of unused dependent care assistance program amounts to plan years ending in 2021 and 2022, or to extend the permissible period for incurring claims to plan years over the same period.

Notice 2021-15, issued in February, states that if an employer adopted a carryover or extended period for incurring claims, the annual limits for dependent care assistance program amounts apply to amounts contributed, not to amounts reimbursed or available for reimbursement in a particular plan or calendar year.

Participants in dependent care assistance programs may continue to contribute the maximum amount to their plans for 2021 and 2022.