October 26, 2006
IRS Confirms & Clarifies Special Divorce Rules For Dependent Care Reimbursement Plans
On September 20, 2006, the IRS issued Notice 2006-86 (the “Guidance”) addressing certain “tie-breaking” rules applicable to dependent care reimbursement plans; specifically in divorce situations.
Special Note: The Guidance also addresses situations other than divorce where more than one person may want to claim a child for various tax purposes. The rules also apply to the dependent care tax credit, the child tax credit, the earned income credit, and the dependency deduction.
Background. Section 129 of the Internal Revenue Code (the “Code”) governs dependent care reimbursement plans. Because the definition of “qualifying child” is broad, it is possible for a particular child to be a “qualifying child” of more than one person. Except for the situation where both persons are the married parents of the child who file a joint tax return, the Code allows only one person to actually treat the child as a “qualifying individual.” This rule applies in divorce situations where the child meets the definition of “qualifying child with respect to each parent.” Only one of the two parents can actually treat the child as a “qualifying child” for purposes of an employer-sponsored dependent care reimbursement plan.
The Guidance confirms this rule and describes how the “parent” is determined.
Tie-Breaker Rules for Divorce. The Guidance provides a tie-breaking rule where the parents are divorced and each parent wants to treat the child as a “qualifying child” for dependent care reimbursement purposes. The parent with custody for the greatest portion of the tax year is entitled to treat the child as a “qualifying child.” This is true even where the other parent is entitled to the child tax credit and dependency deduction. However, if the parent with custody for the majority of the year does not treat the child as a “qualifying child” for purposes of the dependent care reimbursement, and all other purposes, then the non-custodial parent may treat the child as a “qualifying child.”
Recommendations. Because this rule has such a significant impact on an employee’s dependent care reimbursement election, we recommend the following:
- Review your plan document to ensure it accurately describes this rule.
- Review any descriptive materials, including plan summaries, enrollment forms, and reimbursement request forms to ensure it accurately describes this rule.
- Make an extra effort to call this rule to employees’ attention.
- Perform the recommended action items listed above prior to the start of the plan year to which an election to participate relates.
If you have questions regarding this issue, please contact us.