IRS Issues Proposed Regulations on Dependent Care Non-Discrimination Tests.
On August 11, 2026, the Department of Treasury and Internal Revenue Service (IRS) released proposed regulations that clarify that the nondiscrimination requirements that apply to dependent care assistance programs (“DCAPs”) will also apply to Trump Accounts. The proposed regulations provide much needed and rare insight on how the departments interpret the nondiscrimination requirements.
Internal Revenue Code section 129 allows employees to exclude dependent care expenses from gross income through a qualifying DCAP. Trump accounts are accounts individual employees may set up on their own and are treated like individual retirement accounts (IRAs). If properly set up, employers have the option (but not the requirement) to make contributions that are excludable from gross income to the Trump account of an eligible employee or their dependent.
Eligibility to participate in these benefits must not discriminate in favor of highly compensated employees (“HCEs”) or their dependents. HCEs at public agencies are employees who made more than $160,000 (adjusted annually) in the preceding year or were in the top 20 percent of the highest-paid employees during the preceding year. A DCAP and Trump account must satisfy four nondiscrimination standards: (1) the contributions and benefits test; (2) eligibility test; (3) owner concentration test; and (4) average benefits test. The proposed regulations provide information about how the IRS views and administers each component.
The Contributions and Benefits Test
The proposed regulations provide that a Trump account contribution program or DCAP does not satisfy the contributions and benefits test if they provide more favorable terms for HCEs than for other employees. The proposed regulations specify the benefits satisfy the test if they are designed to provide contributions and benefits on the same terms for all employees who are eligible to participate, even if eligible employees receive different amounts of contributions and benefits based on their different elections.
The Eligibility Test
The eligibility test is satisfied if a plan benefits employees who qualify under a classification set up by the employer that is not discriminatory in favor of HCEs or their dependents. The proposed regulations interpret this as requiring eligibility classifications to be reasonable and established under objective business criteria. Reasonable classifications include specified job categories, nature of compensation (salaried or hourly), geographic location, and similar bona fide business criteria.
Under the proposed regulations, a classification would be nondiscriminatory only if the group of employees satisfies either a facts-and-circumstances test or a numerical safe harbor. A facts-and-circumstances test identifies relevant considerations including the underlying business reason for the classification, the percentage of employees eligible under the program, and whether the eligible employees are representative of the workforce across salary ranges, where no one factor is determinative.
The proposed regulations also describe a numerical safe harbor which compares the percentage of non-HCEs who are eligible under the program to the percentage of HCEs who are eligible. A safe harbor percentage is 90 percent, reduced by 3/4 of a percentage point for each whole percentage point by which the non-HCE concentration percentage exceeds 60 percent.
Owner Concentration Test
The owner concentration does not apply to public agency employers since it is focused on ensuring that no more than 25 percent of the amounts paid by the employer for DCAP and Trump accounts are provided to shareholders or owners. Since public agencies do not have shareholders or owners, this test is not applicable.
Average Benefits Test
A DCAP or Trump account satisfies the average benefits test if the average benefits provided to non-HCEs is at least 55 percent of the average benefits provided to the HCEs. The proposed regulations provide a framework for applying this test. The proposed regulations provide an important clarification that this test only takes into account employees who had DCAP or Trump account benefits greater than zero during the plan year, made via salary reduction or employer contribution. The proposed regulations also reinforce that employees whose compensation is less than $25,000 may be excluded from the test. Employers may also exclude employees who are under age 21 and have not completed one year of service, or who are covered by a collective bargaining agreement if there is evidence that the relevant benefits were subject to good faith bargaining.
If a DCAP fails to comply with the nondiscrimination rules, the benefits provided to HCEs are included in their income, but the benefits remain excludable from a non-HCE’s income. If a Trump account fails to comply with the nondiscrimination rules, the arrangement fails to be a Trump account contribution program only with respect to HCEs, but it will not affect the status of Trump account contributions for non-HCEs.
Benefits Compliance Question.
Question: Our agency is preparing for the Affordable Care Act reporting that is due early next year. What is the difference between using code 1A versus 1E on the Form 1095-C, Line 14?
Answer: Codes 1A and 1E are similar and often get confused with each other. Code 1A indicates the employe provided minimum essential coverage (“MEC”) providing minimum value to the employee, their spouse, and their dependent(s) that is affordable under the federal poverty line safe harbor. Whereas, code 1E indicates the employer provided MEC providing minimum value to the employee, their spouse, and their dependent(s) that is affordable under any of the three safe harbors: the federal poverty line safe harbor, the rate of pay safe harbor, or the Form W-2 safe harbor. While code 1A specifically indicates the use of the federal poverty line safe harbor, any of the safe harbors may be used with code 1E.
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