Dependent care FSAs and childcare benefits: how they work, what they cost and what employers should know.
The dependent care assistance plan, the current contribution limit, what expenses qualify, the nondiscrimination tests and how a childcare benefit fits with a tax credit. Written for the owner or HR lead.
A Pre-Tax Account for Care That Lets You Work
A dependent care flexible spending account lets employees pay for childcare and similar care with pre-tax dollars.
What It Is
An employer-sponsored dependent care assistance plan, usually funded by employee salary reduction through a cafeteria plan. Employees elect an amount before the year starts, and it comes out of pay before taxes. It is separate from the health plan and has its own rules, so it needs its own plan document and a clear place in your cafeteria plan. Estimate tax savings with our free dependent care FSA savings calculator.
Who Uses It
Parents of young children, and people who care for a disabled spouse or relative while they work. Participation tends to be uneven, so a short example in your enrollment materials helps. Employees with children in daycare, or an older relative in adult day care, are the most likely to benefit, but many do not realize they qualify.
Employer Cost
Little or none beyond administration, with payroll tax savings on the dollars employees set aside. The main costs are administration, payroll setup and the time to run nondiscrimination checks. Ask your payroll provider and plan administrator how the account is handled in practice before you add it to your offerings.
The Annual Contribution Limit
The household limit rose for plan years beginning in 2026.
The Limit
Starting with 2026, the annual exclusion is $7,500 per household, or $3,750 for married individuals filing separately. It had been $5,000 and $2,500. Employees with a spouse who also has a plan should coordinate so that the household stays within the limit. Because the limit changed, remind staff of the new figure at enrollment and ask a tax adviser about any individual situation.
Household, Not Person
The limit applies to the household. If both spouses have plans, their combined elections cannot exceed it. Spouses at different employers cannot see each other’s elections, so the employee has to track the combined total. Put a reminder on the enrollment form, since over-electing can create a tax problem that the employer cannot easily fix.
Update Your Documents
The plan document and enrollment materials should state the current limit. Check your plan document, summary of benefits and enrollment screens together, since one often lags behind. A short annual review of the figures against current IRS guidance helps you avoid telling employees something out of date.
What Qualifies and What Does Not
The test is care that lets the taxpayer work.
Qualifying Care
Daycare, preschool, before and after-school care, summer day camp and in-home care for a child under thirteen or a dependent who cannot care for themselves. Care must generally be needed so the employee, and a spouse if married, can work or look for work. Ask employees to check with a tax adviser when a situation is unusual, such as a relative who is both a dependent and a caregiver.
Not Qualifying
Overnight camp, tuition for kindergarten and above, and care by the child’s parent or a dependent child under nineteen. Employees sometimes assume any child-related expense counts. Educational costs, enrichment classes and overnight programs often do not, and the line can be fine. Suggest they keep receipts and confirm questionable expenses with a tax adviser before submitting.
Work Required
Both spouses must generally work, be students or be disabled. The expense must let them do so. A spouse who is not working or studying may mean the expense does not qualify. If circumstances change mid-year, such as a job loss, the employee should check how that affects reimbursements and whether the election can be changed.
Provider Information
Employees need the care provider’s name, address and tax identification number to claim reimbursement and to file taxes. Missing information is a common reason claims stall. Ask employees to collect the provider’s tax identification number up front, and explain that a form from the provider can be used. Informal arrangements may still need that information.
It Is Not a Health FSA
The rules are different, and employers get it wrong when they treat the two alike.
Pay as You Go
Employees are reimbursed only up to what they have contributed so far. There is no advance of the full annual election. This catches people who expect a large daycare bill to be reimbursed on day one. Early in the year, only what has been contributed is available, so employees should plan cash flow and submit receipts regularly as balances build.
No Carryover
Dependent care accounts cannot carry unused money into the next year. A grace period of up to two and a half months is optional. Unused funds are generally forfeited, so employees should estimate costs carefully and stay conservative. Check the plan document to see whether a grace period applies, and say so clearly in enrollment communications so staff are not caught off guard.
Election Changes
Changes are allowed for events such as a change in care provider or cost, and for family status events. Changes must generally be consistent with the event. A change in care cost or provider is different from a medical event, and your plan document sets the exact rules. Remind employees to report changes promptly rather than waiting for year end.
Nondiscrimination Tests
These plans must not favor owners and highly paid people.
Eligibility and Benefits
The plan cannot favor highly compensated employees in who is eligible or in the benefits provided. These tests mean owners and higher paid employees cannot receive a better deal than everyone else. Ask your plan administrator whether your plan passes before the year ends, as the fix may be hard once the year is over.
Average Benefits Test
The average benefit for non-highly compensated employees must be at least fifty-five percent of that of the highly compensated. This test compares actual benefits, not just who could enroll, so low participation among lower paid staff can cause a problem. Testing tools or an administrator can run the numbers midyear, giving you time to adjust if results look close.
Owner Concentration
No more than twenty-five percent of the plan’s benefits can go to owners holding more than five percent. In smaller companies, owners may use more of the benefit than other staff, which can matter for this test. Ask your administrator to run the calculation early and tell owners that elections may need to be limited if the test is not met.
How It Interacts With the Child and Dependent Care Credit
Employees cannot use the same expense twice.
Reduction of the Credit Base
Money reimbursed through the account reduces the expenses available for the tax credit. The better choice depends on income. Many families use both, since the tax credit and the account serve different amounts of expenses. Employees should look at their own tax situation with a tax adviser, and the employer should keep communications neutral and factual.
Reporting
The employer reports the amount on the employee’s W-2. Employees file a form with their return. Make sure payroll reports match what the plan reimbursed during the year. A mismatch can cause questions for employees at tax time, so reconcile the totals before W-2s go out and give staff a plain-language note about what to do next.
Neutral Guidance
Tell employees to ask a tax advisor. Do not predict which is better for them. Your role is to explain how the account works, not to say which choice is best for a household. Provide a short, consistent statement in enrollment materials that points employees to a tax adviser or IRS publications for individual questions.
Other Ways Employers Support Care
Some employers go further.
Backup Care
A benefit that provides emergency or backup care for children or adults when regular care falls through. It is often offered through a vendor. Backup care is usually used a few days at a time, so employees who struggle with a sudden gap in care may value it. Review how the vendor charges and who is eligible, and check with a tax adviser on how it is treated.
On-Site or Subsidized Care
A larger commitment with its own tax and legal rules. Get advice before you start. Running a center or contracting for slots raises questions about liability, licensing and benefits testing. Before committing, ask counsel and a tax adviser to review the arrangement, and compare it with lighter options such as backup care or a flexible schedule.
Flexibility
Scheduling and remote work policies often matter as much as a benefit. Mention them in your recruiting materials. Employees with caregiving duties often value predictable schedules and the ability to work remotely when plans change. Say what your policies actually are, and make sure managers apply them consistently so the message in recruiting matches daily experience.
The questions that come before the election form.
Six questions employers bring us about dependent care benefits.
What is the 2026 dependent care FSA limit?
$7,500 per household, or $3,750 for married individuals filing separately.
Can employees use it for elder care?
Yes, for a spouse or dependent who cannot care for themselves and lives with them at least eight hours a day, when the care lets the taxpayer work.
Can the account carry over unused money?
No. Dependent care accounts have no carryover. A grace period is optional.
Do we have to offer one?
No. It is an optional benefit, but it is inexpensive to run.
Can employees change the election mid-year?
Only for permitted events, such as a change in care provider, cost or family status.
Does it count toward the health FSA limit?
No. They are separate accounts with separate limits.
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General information about dependent care benefits, not legal or tax advice. Tax treatment and plan-specific questions belong with your tax advisor and benefits counsel, and we will bring them in.
Is this legal advice?
No. This page is general information, not legal advice. Rules change and facts differ, so confirm your situation with your attorney or tax advisor.
Related guides.
Nondiscrimination Testing for Cafeteria and Self-Funded Plans
The annual tests, who is highly compensated or a key employee, and how small employers avoid testing.
Dependent Care and Family Support
Care benefits and family-friendly policies.
Section 125 Cafeteria Plans
How pre-tax elections work.
FSA and HRA Administration
Running the accounts.
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Laws and rules referenced
26 U.S.C. § 129 — Dependent care assistance programs.
26 U.S.C. § 125 — Cafeteria plans: pre-tax premium payments, plan limits and nondiscrimination rules.
This page is general information, not legal or tax advice. Rules change and facts matter, so confirm your situation with counsel or a qualified advisor.
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