For working parents and employees caring for aging relatives, childcare and elder care costs represent one of the most significant financial pressures of modern life. According to Care.com’s 2024 Cost of Care Survey, the average annual cost of full-time childcare in the United States is $18,000 — more than the average cost of in-state college tuition. Elder care costs are similarly staggering: the median annual cost of adult day care is $20,800, and in-home aide services average $61,776 per year nationally.
The Dependent Care Flexible Spending Account (DCFSA) — also known as a Dependent Care FSA or just “Dependent Care FSA” — is a tax-advantaged benefit that helps employees manage these costs using pre-tax dollars. For small business employers, it’s one of the most impactful benefits you can offer working parents and caregivers at essentially zero cost to the company.
What Is a Dependent Care FSA?
A Dependent Care FSA is an employer-sponsored benefit account that allows employees to set aside pre-tax dollars from their paycheck to pay for eligible dependent care expenses. The money is deducted from gross pay before federal income tax, Social Security tax, and Medicare tax are calculated — generating immediate tax savings on every dollar contributed.
The IRS sets the annual contribution limit for DCFSAs. For 2024, the limit is $5,000 per household for married couples filing jointly or single filers ($2,500 for married individuals filing separately). These limits have been unchanged since 1986, despite childcare costs rising dramatically — a frequent source of frustration among benefits advocates. However, even at $5,000, the tax savings are meaningful: an employee in the 22% federal tax bracket saves approximately $1,500 in federal taxes alone on a full $5,000 contribution.
Unlike Health FSAs, which allow employees to access the full annual election amount on day one of the plan year, DCFSA funds are only available as they are deposited. Employees contribute through payroll deduction throughout the year and can only be reimbursed for expenses up to the amount currently in their account.
Who Qualifies as a Dependent for DCFSA Purposes?
The IRS definition of a qualifying dependent for DCFSA purposes is more specific than it might seem. Qualifying dependents include children under age 13 whom the employee claims as a tax dependent, and any person of any age (including a spouse or parent) who is physically or mentally incapable of caring for themselves and lives with the employee for more than half the year.
The “incapable of self-care” requirement for adult dependents is an important nuance. The dependent must require the employee’s presence because they cannot dress, clean, or feed themselves due to a physical or mental condition. An aging parent who is mentally capable but prefers not to be alone does not qualify. However, a parent with advanced dementia, severe physical disability, or similar condition that genuinely prevents independent self-care does qualify.
Employees considering whether an elder care expense qualifies should consult IRS Publication 503 (Child and Dependent Care Expenses) or speak with a tax advisor. The rules are specific, and using DCFSA funds for non-qualifying expenses creates a tax liability.
What Expenses Are Eligible for Reimbursement?
Eligible DCFSA expenses include any care that allows the employee (and their spouse, if married) to work or look for work. For children under 13, this includes: licensed daycare centers, preschool tuition (but not kindergarten or higher), after-school care programs, summer day camps (but not overnight camps), and in-home babysitters or au pairs. The care provider cannot be the employee’s spouse, the child’s parent, or the employee’s own child under age 19.
For elder care, eligible expenses include adult day care centers, in-home aides, and similar services that allow the employee to work while the dependent is cared for. Nursing home or assisted living facility costs are only eligible if the primary reason for placement is the dependent’s incapacity, not general preference or convenience.
Ineligible expenses include overnight camp tuition, tutoring, clothing, food (unless inseparable from care services), and medical care. The line between “care” and “education” can be blurry for preschool programs — generally, if the primary purpose of the program is supervision and care (not curriculum-based education), the expense qualifies.
How Employers Set Up a DCFSA
For employers, offering a DCFSA is administratively simple and generates a tangible tax benefit. When employees make pre-tax DCFSA contributions, the employer saves the 7.65% employer share of FICA taxes (Social Security and Medicare) on those dollars. For a small business with 20 employees each contributing $5,000, the employer saves approximately $7,650 in payroll taxes annually — a real bottom-line benefit.
Employers must adopt a written Section 125 Cafeteria Plan document to legally offer FSAs. This is a straightforward legal document that most benefits administration platforms and third-party administrators (TPAs) provide. The plan must be formally adopted before the start of the plan year — retroactive elections are not permitted.
Day-to-day administration is typically handled by a TPA or benefits platform like WEX, HealthEquity, Flores, or PayFlex. Employees submit claims (receipts and documentation) through the platform and receive reimbursement via direct deposit or a benefits debit card. Employers don’t adjudicate individual claims — that’s the TPA’s job.
DCFSA vs. the Child and Dependent Care Tax Credit
The DCFSA is not the only tax benefit available to employees with dependent care expenses. The Child and Dependent Care Tax Credit (CDCTC) is a federal tax credit available to all working taxpayers with qualifying dependents — no employer action required. However, the two benefits cannot be used for the same expenses, so employees must choose which to apply to each dollar of care costs.
For most employees, the DCFSA provides greater tax savings than the CDCTC, particularly those in higher tax brackets. The CDCTC is a credit worth 20% to 35% of up to $3,000 in expenses (one dependent) or $6,000 (two or more dependents), which translates to a maximum credit of $600 to $1,050. By contrast, a DCFSA contribution saves federal income tax at the employee’s marginal rate plus FICA taxes — a combined savings often exceeding 30%.
The optimal strategy depends on the employee’s tax situation, number of dependents, and total care costs. Employees with care costs exceeding $5,000 may benefit from using the DCFSA for the first $5,000 and the CDCTC for remaining expenses. Employees with very low incomes may find the CDCTC (which can be partially refundable) more valuable. A tax advisor can model the optimal approach for each employee’s situation.
The “Use It or Lose It” Rule and Grace Periods
DCFSA funds operate under the “use it or lose it” rule: unused funds at the end of the plan year are forfeited. Unlike Health FSAs, there is no option for a rollover of unused DCFSA funds. However, employers may offer a 2.5-month grace period after the plan year ends during which employees can submit claims for expenses incurred after year-end — giving them until March 15 to use funds from a calendar-year plan.
The forfeiture risk means employees should estimate their care costs carefully before electing a DCFSA contribution amount. Employees whose care arrangements are unpredictable — a nanny who might leave, a daycare spot that might not materialize — should elect conservatively. It’s better to use the CDCTC for additional costs than to forfeit DCFSA funds.
Employers keep forfeited DCFSA funds (after the TPA’s administrative fees). Some employers choose to use this money to offset plan administration costs or redistribute it to participating employees in compliance with nondiscrimination rules. The amounts are typically small, but the employer should understand the mechanics before establishing the plan.
Dependent Care FSA Nondiscrimination Rules
DCFSAs must pass IRS nondiscrimination tests to ensure they don’t disproportionately benefit highly compensated employees (HCEs) or key employees. The tests compare participation rates and benefit amounts between HCEs and non-HCEs. If the plan fails nondiscrimination testing, HCEs may have their pre-tax benefits reduced or eliminated for that year, creating an unexpected tax liability.
For most small businesses, nondiscrimination testing is straightforward, and plans pass without issue. However, employers should work with their TPA to run tests annually, particularly if the workforce is heavily skewed toward higher earners or if participation among lower-wage employees is low. Proactive testing prevents unpleasant surprises at year-end.
Frequently Asked Questions
Can both spouses contribute to a DCFSA if they work for different employers?
Yes, but the combined household limit is still $5,000 (or $2,500 each if filing separately). If both spouses contribute, they must ensure their combined elections don’t exceed the household limit. Exceeding the limit results in the excess being included in gross income and subject to tax.
What happens to DCFSA funds if an employee leaves mid-year?
When an employee terminates employment, DCFSA participation generally ends. Employees can submit claims for eligible expenses incurred while they were employed and enrolled, up to the balance available in their account. Any remaining balance is typically forfeited. COBRA does not apply to DCFSAs the same way it applies to health FSAs — employees cannot continue contributions after termination.
Can I use DCFSA funds for a summer day camp?
Yes — summer day camps are an eligible expense, provided the camp is day-only (not overnight). The full cost of a day camp is eligible, even if the camp has an educational or themed component. Overnight camps are not eligible, regardless of how educational they are.
Does offering a DCFSA affect my company’s ACA reporting obligations?
A standalone DCFSA (not bundled with health coverage) does not create ACA reporting obligations on its own. However, if your company offers health coverage and is an applicable large employer (50+ full-time equivalent employees), ACA reporting requirements apply regardless of DCFSA status. Most small businesses under 50 FTEs are not subject to ACA employer reporting.
Can an employee change their DCFSA election mid-year?
Generally no — DCFSA elections are irrevocable for the plan year once made. However, certain qualifying life events (birth or adoption of a child, change in care costs due to a provider change, change in the employee’s or spouse’s employment status) allow mid-year election changes consistent with the change in circumstances. The specific rules are defined in the plan document.
Offer Tax-Smart Benefits That Make a Real Difference
A Dependent Care FSA is one of those rare benefits that costs the employer almost nothing while delivering meaningful, tangible financial relief to employees with children or aging relatives. Setting one up correctly — with proper plan documents, TPA administration, and employee education — is exactly the kind of detail that experienced benefits brokers handle every day.
Garden State Benefits, led by broker Paul Z Olah, helps small businesses across New Jersey and 25 additional states design benefits packages that include tax-smart options like Dependent Care FSAs, Health FSAs, HSAs, and HRAs. Paul can help you evaluate whether a DCFSA makes sense for your workforce and connect you with the right TPA to administer it.
Call 856-880-6340 or email paul@gardenstatebenefits.com. At Garden State Benefits, you call and Paul answers — no hold music, no callback requests.