Proposed rules for dependent care assistance plans

Tax Hot Topics

The IRS recently issued proposed regulations (REG-101355-26) addressing the nondiscrimination rules for dependent care assistance programs (DCAPs).

A DCAP is a separate written plan of an employer for the exclusive benefit of its employees that provides dependent care assistance and meets certain other requirements under Section 129. This provision excludes from an employee’s taxable compensation amounts paid or incurred by an employer for dependent care assistance, subject to an annual cap of $7,500 ($3,750 for  a married individual filing a separate return).

Generally, the requirements for an employer to establish and maintain a DCAP include, among others:

• A written plan. The program must be maintained under a separate written plan for the exclusive benefit of employees. A DCAP can cover service providers who are employees under the common-law standard and self-employed individuals such as partners, sole proprietors, nonemployee directors or 2% shareholders of S corporations.
• Reasonable notification. All eligible employees must be given reasonable notification of the availability and terms of the DCAP.
• A written statement. An employee must receive by Jan. 31 a written statement showing the amounts paid or expenses incurred by the employer in providing dependent care assistance to the employee during the previous calendar year.
• Eligibility nondiscrimination. The employer's eligibility classification cannot favor highly compensated employees (HCEs).
• Contributions and benefits nondiscrimination. The contributions or benefits provided under the program cannot favor HCEs.
• 25% owner concentration test. No more than 25% of the amounts paid or incurred by the employer for dependent care assistance during the year may be provided to  individuals who are shareholders or owners (or their spouses or dependents), each of whom (on any day of the year) owns more than 5% of the stock or of the capital or profits interest in the employer.
• 55% average benefits test. The average benefits provided to non-HCEs under all DCAPs of the employer for each year must be at least 55% of the average benefits provided to HCEs.

If a DCAP fails one or more of the nondiscrimination rules, the benefits are generally not excludable from income by HCEs, but the benefits are excludable from income by employees who are not HCEs. However, the proposed rules also include remedial rules for failures of the 55% average benefits test and 25% owner concentration test. These remedies would require an employer, before the deadline for furnishing Form W-2s for a year, to include in the gross income of affected HCEs the amount of “excess benefits” determined under the proposed regulations.

These Section 129 proposed regulations were issued in conjunction with the new Trump account contribution program (TACP) proposed rules, which were added by the 2025 law known as the One Big Beautiful Bill Act. TACPs permit an employer to contribute to the Trump account of an employee or an employee’s dependent on a basis excludable from the employee’s gross income.