The IRS released the final regulations under Code Section 21 which have a direct impact on Dependent Care Flexible Spending Accounts (FSA). These final regulations are effective August 14, 2007.
The proposed regulations were issued in May 2006 and you can see highlights listed in the June 2006 DataPath newsletter.
How do the final regulations affect the Dependent Care FSA under your cafeteria plan? Code Section 129 limits reimbursement to employment related expenses as defined in Code Section 21.
The expense must be for a qualifying individual as defined in section 152. The qualifying individual is either a qualifying child who has not attained age 13; a taxpayer’s dependent who is physically or mentally incapable of self-care and who has the same principal place of abode as the taxpayer for more than half of the tax year; or the taxpayer’s spouse who is physically or mentally incapable of self-care and who has the same principal place of abode as the taxpayer for more than half of the tax year.
The status of an individual as a qualifying individual is determined on a daily basis.
The purpose of the expenses must be to enable the taxpayer to be gainfully employed.
The expenses must be for services performed during the period in which the taxpayer is gainfully employed or is in active search of gainful employment. Employment may consist of service within or outside the taxpayers home and includes self-employment.
An expense is not employment related merely because it is paid or incurred while the taxpayer is gainfully employed. The purpose of the expense must be to enable the taxpayer to be gainfully employed.
Expenses paid for a period during only part of which the taxpayer is gainfully employed or in active search of gainful employment must be allocated on a daily basis; however, the final regulations provide a couple of practical exceptions:
· Short temporary absences due to vacation or illness if the individual is required by the day care provider to pay for the days that the child is absent. Short temporary absence has been defined as an absence of no more than 2 consecutive calendar weeks.
· A taxpayer who is employed part-time must allocate expenses for dependent care between days worked and days not worked. However, if the taxpayer is required to pay for dependent care on a periodic basis (such as weekly or monthly) that includes both days worked and days not worked, the taxpayer is not required to allocate the expenses. A day on which the taxpayer works at least 1 hour is a day of work.
Summer school and tutoring programs are considered educational and not for the care of a qualifying individual and therefore do not qualify as dependent care.
The cost of overnight care for a taxpayer who works may be viewed as an employment related expense.
The cost of overnight camp is not an employment related expense and therefore not reimbursable.
Day for a qualifying child where one parent works during the day and the other works during the night and sleeps during the day is viewed as an employment related expense.
Expenses for kindergarten and above are presumed to be for education and not reimbursable.
Highlights from the proposed regulations issued on May 24, 2006, can be found at the following link:
http://dns.dpath.com/dpathemailer/redesign/june/dependentcare.html
The final regulations can be found at the following link:
http://a257.g.akamaitech.net/7/257/2422/01jan20071800/edocket.access.gpo.gov/2007/pdf/E7-15753.pdf
