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IRS clarifies dependent care relief

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Tax Hot Topics newsletter The IRS has issued guidance (Notice 2021-26) clarifying the temporary dependent care assistance relief provided by the Taxpayer Certainty and Disaster Tax Relief Act of 2020, enacted as Division EE of the Consolidated Appropriations Act, 2021 (CAA).

The CAA provides the temporary ability to allow unused dependent care assistance benefits remaining at the end of a plan year ending in 2020 or 2021 to reimburse dependent care expenses incurred in the next plan year, either due to a carryover or an extended period (up to 12 months) for incurring claims.

Notice 2021-26 clarifies that, if these dependent care benefits would have been excluded from income if used during the preceding taxable year (that is, during the taxable year ending in 2020 or 2021, as applicable), they will remain excludible from gross income and are not wages of the employee for taxable years ending in 2021 and 2022. In addition, the notice clarifies that these benefits will not be taken into account for purposes of the application of the limits under Section 129 to other dependent care benefits available for the taxable years ending in 2021 or 2022.

Notice 2021-26 also clarifies the temporary relief provided by the American Rescue Plan Act of 2021 (ARP), which increases the maximum dependent care limit from $5,000 (in 2020) to $10,500 (half that amount in the case of a married individual filing separately) with respect to any taxable year beginning after Dec. 31, 2020, and before July 1, 2022. This increased exclusion amount applies with respect to an employee’s 2021 taxable year (typically the 2021 calendar year), and not the plan year. Thus, in the case of a dependent care assistance plan with a non-calendar plan year, the increased exclusion amount will not apply to reimbursement of expenses incurred during the 2022 portion of the plan year. Notice 2021-26 provides examples illustrating the possible tax consequences of electing $10,500 in dependent care benefits for a plan year beginning in 2021 but ending in 2022.

Contact:
Jeff Martin
Partner
Washington National Tax Office
T +1 202 521 1526

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