Dependent Care Assistance Programs Under Section 129
A dependent care FSA is not a health plan. It is an employer program under its own section of the tax code, with its own limits and tests, and the annual limit has risen from $5,000 to $7,500.
What Section 129 Allows
Section 129 of the Internal Revenue Code excludes employer-paid dependent care assistance from income when a qualifying program is in place.
The Annual Cap
$7,500 for taxable years beginning after 2025, or $3,750 for a married person filing separately. The cap was $5,000 before that. Employers should make sure payroll, the plan document and employee materials all show the same limit for the year. A tax adviser can confirm how the cap applies to employees with unusual filing situations.
The Earned Income Limit
The exclusion cannot exceed the employee’s earned income. For married employees it is limited to the lower of the two spouses’ earned income, with special rules for a spouse who is a student or unable to care for themselves. Employees with a working spouse often find the lower earner’s pay sets the limit. HR can remind them to check this before electing, since the plan can only help with the amount their income allows.
Qualifying Services
Services that would qualify as employment-related dependent care expenses if the employee paid for them directly. Typical examples include child care for a young child while parents work, and certain care for another dependent who cannot care for themselves. Costs such as tuition for older children generally do not count, so check with a tax adviser.
Related Individuals
Payments to certain related individuals, including dependents the employee or spouse claims and the employee’s children under 19, do not qualify. Payments to the employee’s spouse, to a person the employee or spouse claims as a dependent, or to the employee’s own child under 19 are not eligible. Employees should confirm their provider is eligible before claiming a reimbursement.
Amounts Above The Cap
Assistance above the cap is taxable in the year the services are provided. Employees who contribute more than the cap, or who receive employer assistance that puts the total over it, may see the extra amount in taxable pay. Payroll should monitor totals so employees are not surprised.
No Double Benefit
Excluded amounts cannot also be claimed as a deduction or credit. An employee cannot use the same dollars for the plan exclusion and for a credit on their tax return. Employees should speak with a tax adviser about which approach fits their household in a given year.
What the Program Must Satisfy
These requirements are what separate a dependent care FSA from simple payroll deductions.
A Separate Written Plan
The program must be a separate written plan for the exclusive benefit of employees. It does not have to be funded. Written plan terms should spell out eligibility, how elections are made and what expenses are covered. Review the document each year with counsel, and share the terms with employees in plain language.
Nondiscrimination
The program cannot discriminate in favor of highly compensated employees or their dependents. Employers should run the tests with their administrator and keep the results on file. Owners and higher-paid staff who participate heavily can cause the plan to fail, so check the numbers before year end. In August 2026 the IRS proposed detailed nondiscrimination rules for these programs, including an eligibility safe harbor, a test that average benefits for non-highly compensated employees be at least 55 percent of those for highly compensated employees, and a restatement of the limit on benefits to owners of more than five percent. They would apply to plan years beginning on or after the date final regulations are published, and employers may rely on the proposal earlier.
The Benefits Test
Average benefits for employees who are not highly compensated must be at least 55% of the average for highly compensated employees. Employees earning under $25,000 may be disregarded in salary reduction arrangements. The test compares participation by employees at different pay levels, so a plan that mostly benefits higher earners can fail. Ask the administrator for a mid-year read so changes can be made in time.
The Owner Limit
No more than 25% of the program’s benefits can go to shareholders or owners holding more than 5%. Owners who participate should check the plan’s results before they commit to a large election. A tax adviser can help the employer model the outcome and design contribution limits if needed.
Reasonable Notice
Eligible employees must receive reasonable notice of the program. Notice can be given through the benefits guide, enrollment materials or an HR portal. Keep a copy of what was provided and when, so the employer can show eligible employees received it.
The January 31 Statement
By January 31, the employer must give each employee a statement of the prior year’s amounts. Many employers include the amounts on a year-end report or on the W-2, and the dates should be set early. Ask payroll who prepares the statement and who checks it before it goes out.
Practical Points for Employers
The rules above lead to a short list of things to get right each year.
Plan Through Section 125
Most employers offer dependent care through a cafeteria plan so employees contribute pre-tax. See our Section 125 guide.
Update For The New Cap
Check the plan document, payroll limits and employee communications for the $7,500 figure. Search every place the old figure may appear, such as enrollment forms, FAQs, the benefits portal and the plan document. Update them together and tell employees of the change before the next election period.
Collect Provider Information
Employees’ returns must include the provider’s name, address and taxpayer ID, so reimbursement requests should capture them. Employees need the care provider’s name, address and tax identification number to complete their own tax forms. Collect them with each reimbursement request, and remind employees to keep receipts.
Run The Tests
Ask your administrator to run the nondiscrimination and 55% benefits tests at the end of the plan year. Ask for a written schedule of the tests, who reviews the results and what happens if the plan fails. Early testing leaves more time to address any problems before the plan year closes.
Do Not Mix It With Health FSA
The dependent care limit is separate from the $3,400 health FSA limit. The two accounts have their own limits and rules, and money cannot move between them. Make sure enrollment materials describe each one clearly, so employees do not confuse the amounts they can elect.
Send The Statement
Put the January 31 date on the compliance calendar. Set up a reminder for early January, and name the person who prepares and checks the statements. Confirm the delivery method with the administrator, and keep a record of when the statements were sent.
Questions We Get About Dependent Care Assistance
What is the dependent care FSA limit?
$7,500 for taxable years beginning after 2025 ($3,750 if married filing separately). It was $5,000 before.
Is it the same as a health FSA?
No. It is a separate program under Section 129 with its own limit.
Do we need a written plan?
Yes. A separate written plan for the exclusive benefit of employees is required.
What tests apply?
A nondiscrimination requirement, a 55% average benefits test, and a 25% limit on benefits to owners holding more than 5%.
Is there an earned income limit?
Yes. The exclusion cannot exceed the employee’s earned income, or for married employees the lower spouse’s earned income.
What expenses qualify?
Those that would qualify as employment-related dependent care expenses if the employee paid directly.
Can we pay a relative?
Not certain related individuals, including dependents the employee or spouse claims and the employee’s children under 19.
What do we send employees in January?
A statement of the amounts provided for the prior year, due by January 31.
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
Related reading: Dependent Care and Family Support · Section 125 Cafeteria Plans · HSA, FSA and Section 125 Limits · FSA, HRA and HSA Coordination · Student Loan Repayment · Adoption Assistance Programs Under Section 137
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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.
Proposed regulations, 91 Fed. Reg. 51611 (Aug. 11, 2026) — Nondiscrimination rules for dependent care assistance programs under Section 129, proposed alongside Section 128 rules for Trump Account contributions.
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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