A Dependent Care Assistance Plan (DCAP)—sometimes known as a Dependent Care FSA (Flexible Spending Account)—is a powerful benefit tool under IRC Section 129 that lets employees set aside pre-tax dollars to pay for eligible childcare expenses. This plan helps working parents ease the burden of care costs while also reducing payroll taxes.
Under Internal Revenue Code Section 129, employers may offer a dependent care benefit that allows employees to contribute up to $5,000 per year (or $2,500 if married filing separately) from their salaries before taxes. These contributions can be used to offset qualifying dependent care expenses, such as daycare, preschool, before/after school programs, summer day camps, and care for disabled dependents.
Because contributions are withheld from wages before federal income tax, Social Security tax, and Medicare tax, participants see tax savings—effectively reducing their taxable income.
How the Plan Works
Election
At the start of a plan year (or during an open enrollment period), employees make an election indicating how much pre-tax income they want to allocate to the DCAP FSA, up to the IRS limits.
Contributions & Withholding
The employer withholds that amount periodically (e.g., monthly, biweekly) from the employee’s gross wages before taxes.
Reimbursement
When the employee incurs eligible dependent care expenses, they submit documentation (receipts, vendor statements) to the FSA administrator. The administrator reimburses the employee from the funds withheld.
Tax Benefits for Both Parties
Employees: Because the contributions are pre-tax, the employee lowers their federal income tax, Social Security tax, and Medicare tax liability.
Employers: Employers save on their share of payroll taxes (e.g., Social Security, Medicare) because the amount withheld is exempt.
Benefits & Considerations
Advantages:
Tax savings: Participants can save up to approximately 30% (varies by income and tax bracket) on dependent care through tax‑free contributions.
Employer attraction & retention: Offering DCAP FSA can make a benefits package more appealing to working parents, increasing employee satisfaction and retention.
Payroll tax reduction for the employer as well as for employees.
Important Limitations & Rules:
Funds must be used for eligible dependent care expenses.
Use‑it-or-lose-it: Contributions not used during the plan year may be forfeited (unless the plan allows a carryover or grace period).
Employees must have earned income, and the care must be “necessary” for them to work or attend school.
The employer must adopt a written plan, provide a Summary Plan Description, and follow nondiscrimination testing.
Only a minority of employers currently offer such a plan (about 10%, per some reports).
In Summary
A Dependent Care Assistance Plan FSA under IRC Section 129 offers a smart, tax-advantaged way for employees to subsidize childcare or other dependent care, while also helping employers save on payroll taxes. When properly implemented and communicated, it becomes a win‑win benefit—relieving cost pressure for working parents, improving employee loyalty, and reducing employer tax costs.
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