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A DCAP is an employer-sponsored plan, usually offered through a cafeteria plan, that lets employees set aside pre-tax pay to reimburse eligible dependent care expenses such as daycare, preschool, or after-school care that allow them to work. Contributions are exempt from federal income tax and FICA taxes.
Authorized by Internal Revenue Code section 129 and typically funded by salary reduction under a section 125 cafeteria plan, a DCAP reimburses qualifying care costs for children under 13 and for a spouse or dependent who is physically or mentally incapable of self-care and shares the employee's home. The care must enable the employee, and the spouse if married, to work or look for work. Overnight camp, tuition for kindergarten and above, and care provided by the employee's own child under 19 do not qualify. The IRS adjusts the annual exclusion limit from time to time, so check the current-year figure.
Operationally, employees elect an amount before the plan year, and funds become available only as they are contributed. Unlike a health FSA, there is no requirement to advance the full election. Claims must be substantiated with the provider's name, tax identification number, dates, and amount, and unused balances are generally forfeited under the use-or-lose rule unless the plan allows a grace period. Reimbursed amounts appear in box 10 of the employee's Form W-2.
Two issues catch employers. DCAPs must pass nondiscrimination tests, and highly compensated employees often see elections cut back when participation among other employees is low. For the care costs a DCAP is not permitted to reimburse, such as overnight camp, some employers add a lifestyle spending account, which reimburses whatever categories the employer chooses but pays in taxable dollars rather than pre-tax ones. Employees also need to know that dollars run through a DCAP reduce the expenses available for the federal child and dependent care tax credit described in IRS Publication 503.
Care that lets the employee, and the spouse if married, work or look for work. That covers day care, preschool, before and after school care, and day camp for children under 13, plus care for a spouse or dependent incapable of self-care who lives with the employee. Overnight camp and school tuition do not qualify.
Only if a permitted change in status occurs, such as a change in the cost or coverage of care, a change in marital or employment status, or a child aging out. The plan document controls which events apply and the change must be consistent with the event, so route requests through the plan administrator.
It depends on the household. Dollars run through a DCAP escape income and payroll tax but reduce the expenses available for the federal credit, so employees cannot use the same costs twice. Higher earners often benefit more from the exclusion, while lower earners may do better with the credit. Encourage employees to compare both.