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Proposed Regulations on Dependent Care Expenses

June 12, 2006

The IRS recently issued proposed regulations regarding dependent care expenses. The regulations specifically relate to the dependent care tax credit under Section 21 of the Internal Revenue Code (Code), but many of the requirements also apply to expenses under a dependent care flexible spending account (FSA). In addition to incorporating statutory changes made over the years, the new regulations clarify certain requirements and provide some new interpretations. Here’s a quick summary of some key issues:

  • Kindergarten. The proposed regulations incorporate the widely accepted rule that expenses for programs below kindergarten level (e.g., preschool) may be qualifying expenses, but those for programs at kindergarten level and above are primarily educational and do not qualify.
  • Day Camp. The proposed regulations clarify that the cost of day camp may be a qualifying expense even if the camp specializes in a particular activity, such as computers or music.
  • Transportation. The proposed regulations provide that the cost of transportation furnished by a dependent care provider to or from the place where care is provided (e.g., a day camp or off-site after-school program) may be a qualifying expense. This appears to be a new, more liberal rule.
  • Indirect Expenses. The proposed regulations clarify that indirect expenses related to dependent care (such as application fees, agency fees, and deposits) may be qualifying expenses if they must be paid in order to obtain the care, and the care is ultimately provided. For example, if a deposit reserving a child’s spot in a program is forfeited because the child is ultimately enrolled in another program, the deposit would not qualify. Official guidance on this issue is new, but it is consistent with prior informal statements.
  • Absences from Work. The proposed regulations provide that, in general, dependent care expenses for a period of absence from work (whether paid or unpaid) are not employment related and therefore are not qualifying expenses. For example, expenses for child care provided during an employee’s 4-month paid absence from work due to illness would not qualify. However, for administrative convenience, the regulations provide that dependent care expenses paid on a weekly, monthly, or annual basis will still qualify in full without regard to short, temporary absences from work, such as for vacation or minor illness.
  • Part-Time Work. For individuals who work part-time, but who are 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 entire dependent care fee may be a qualifying expense. However, an example in the regulations indicates that if an employee only works three days per week and the dependent care center provides a reduced fee for three days per week, but the employee signs the child up for five days per week, only the amount of the three-day fee is a qualifying expense.
  • Effective Date. The proposed regulations may be relied upon immediately. If the FSA plan document defines eligible dependent care expenses as employment related expenses under Code Section 21, amendments to the plan document should not be necessary.

Please feel free to contact Ira H. Goldman at 860-251-5820 or igoldman@goodwin.com if you have any questions regarding the new regulations or other FSA issues.

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