Recently, President Joe Biden signed into law the American Rescue Plan Act of 2021 (ARPA) which impacts employers’ dependent care flexible spending account (FSA) plans. ARPA allows employers to increase the limit of dependent care expenses that a participating employee may exclude from his or her gross income under a dependent care FSA to $10,500 (increased from $5,000) for single taxpayers and married taxpayers filing taxes jointly, and to $5,250 (increased from $2,500) for married individuals filing separately. These increases are effective only for the calendar year 2021.
ARPA also allows employers to retroactively amend a stand-alone dependent care FSA, or one contained in an IRS Code section 125 cafeteria plan, so long as the employer (1) adopts an amendment to its plan no later than the last day of the plan year in which the amendment is effective (this means December 31, 2021, for calendar year plans); and (2) operates the plan consistent with the amended terms during the period beginning on the effective date of the amendment and ending on the date the amendment is adopted. Notably, ARPA does not require employers to increase the exclusion limits under their plans but merely permits them to do so.
Congress also recently enacted the Consolidated Appropriations Act of 2021 (CAA) which provides, in part, additional temporary dependent care FSA flexibility.
CAA has implications for employers seeking to increase their 2021 dependent care FSA exclusion limits. Specifically, CAA allows employers to permit dependent care FSA participants to roll over unused funds from their FSA account from 2020 to 2021, and from 2021 to 2022. Under CAA, employers can also permit employees to make mid-year changes to their dependent care FSA salary reduction contribution amounts without experiencing a qualifying election change event, such as a marital status change, or the birth or adoption of a child. These CAA provisions are both optional for employers.
Employers should be aware that if they intend to increase their dependent care FSA exclusion limits for 2021, and they do not also allow employees to make mid-year election changes without a qualifying reason, only employees who experience a qualifying event could take advantage of the increased limits.
Additionally, if employers opt to implement CAA’s permissive unlimited carryover of unused amounts from 2021 to 2022, and also adopt ARPA’s increased exclusion limits, employees could end up with very large account balances in 2022. As a result, employers should consider the implications of both laws before deciding to take advantage of the temporary flexibility provided by one or both.