September 10, 2007
Final IRS Regulations Issued Regarding Dependent Care Reimbursement Expenses
On August 13, 2007, the IRS published final regulations under Section 21 of the Internal Revenue Code (the “Code”) [Treas. Reg. Secs. 1.21-1 through 1.21-4, 72 Fed. Reg. 45338 (Aug. 14, 2007)] regarding expenses that constitute “employment-related expenses.” Under Section 129 of the Code, dependent care assistance programs (“DCAPs”) may reimburse only “employment-related expenses” as defined under Section 21. Accordingly, the final regulations directly impact the expenses that may be reimbursed under DCAPs.
The final regulations are based upon proposed regulations released in May 2006. On June 5, 2006, we issued a client alert describing the key features of the proposed regulations (our client alert can be viewed here). By and large, the final regulations incorporate the rules contained in the proposed regulations. However, there are several differences, including:
- The final regulations clarify that, although expenses for day camp are generally eligible expenses (even if the camp specializes in a particular activity), expenses for summer school and tutoring are not eligible because they are educational in nature.
- The final regulations modify the rules regarding expenses incurred during temporary absences from work. Normally, expenses would not be reimbursable while the employee is absent from work because expenses must be incurred to allow the employee to work. However, under the proposed regulations, the IRS recognized that employees must at times pay their day care provider even though the employee is absent from work. The proposed regulations provided that expenses incurred while an employee is temporarily absent from work are reimbursable if the employee must pay for care on a weekly, monthly, or longer basis. The final regulations expand this rule to allow employees who are temporarily absent from work to obtain reimbursement for fees that must be paid while the employee is not working even if not paid on a weekly, monthly, or longer basis. For example, if the provider charges a daily rate but requires payment when the child is absent, such payments would be reimbursable while the employee is temporarily absent from work. The final regulations also indicate that an absence of no more than two (2) consecutive weeks will be deemed to be a temporary absence.
Effective Date. The final regulations are effective immediately.
Note: Employers have been allowed to rely on the proposed regulations since their issuance last year.
Action Items. Employers and third-party administrators should take the following steps in light of the final regulations:
- Review DCAP plan documents to ensure the description of eligible expenses is consistent with, and not broader than, the rules contained in the final regulations. If you want to incorporate the definition of eligible expense contained in the final regulations, an amendment to the plan document may be needed if the document does not define eligible expense as the maximum permitted by law.
Note: DCAPs are not required to reimburse expenses up to the fullest extent allowed by the Code. Accordingly, employers are not required to incorporate the changes included in the regulations to the extent the changes have expanded the expenses that may be reimbursed under a DCAP.
- If the DCAP begins applying the rules mid-plan year, and the “newly recognized” rules impact an employee’s eligible expenses (e.g., the employee has additional eligible expenses under the new rules), allow the employee to change his/her election under the cafeteria plan to take into account the new eligible expenses. Such a change is allowed only if your cafeteria plan incorporates the exceptions to the irrevocable election rule contained in the cafeteria plan regulations.
- If the DCAP is amended to incorporate the new rules or the plan already defines eligible expense to be the maximum permitted by law, update descriptive materials to incorporate the rules contained in the final regulations.
For those with open enrollment occurring this fall, having updated descriptive materials available prior to open enrollment will be important because it will allow employees to make elections with a full understanding of what is reimbursable under the plan.
- If the DCAP is amended to incorporate the new rules or the plan already defines eligible expenses to be the maximum permitted by law, begin (either immediately or upon amendment) adjudicating claims in accordance with the rules contained in the final regulations. Employers that self-administer their DCAP, and third-party administrators that administer DCAPs, should review their internal guidelines used to adjudicate dependent care expenses to ensure they are consistent with the final regulations.
If you would like our assistance addressing either of these items, please contact us.