ErisaALERT 2006-05 Dependent Care Expenses -Erisa Diagnostics, Inc

June, 2006

IRS Proposed Regulations on Dependent Care Expenses

WHAT IS IT: In May 2006, the IRS issued proposed regulations under IRC Section 21 relating to the dependent care tax credit. The proposed rules renumber, restructure and are intended to improve clarity of regulations that were written over 20 years ago. The new proposed regulations include changes that had been made to original regulations and offer useful examples for plan sponsors.

WHY IS IT IMPORTANT?-These regulations are important to plans sponsors offering Dependent Care Assistance Plans under IRC Section 129 because Section 129 defines dependent care assistance as the payment of expenses for services which would be considered employment related expenses under Section 21.

HIGHLIGHTS OF THE PROPOSED REGULATIONS:

Gainful employment

The purpose of the expenses for a qualifying individual must be to enable the tax payer to be gainfully employed. The qualifying individual must have the same principal place of residence as the taxpayer for more than one half the taxable year.
In general, dependent care expenses for a period in which the taxpayer is absent from work are not employment – related expenses. However, short, temporary absences from work, such as minor illness or vacation, are disregarded if dependent care expenses are paid on a weekly or longer basis.
Taxpayers who work part-time must allocate expenses between days worked and days not worked. However, taxpayers who work part-time but are required to pay for dependent care expenses on a weekly or longer basis are not required to allocate expenses between days worked and days not worked.
Payments to either the taxpayer’s spouse or to a parent of the taxpayer’s child who is not the taxpayer’s spouse do not qualify for the credit.

Kindergarten, overnight camps, day camps and transportation

Expenses of pre-school or similar programs below the kindergarten level are for care and may be employment related expenses
Expenses for programs at the level of kindergarten and above, are primarily for education and are not employment related expenses
The full amount paid for a day camp or similar program may be for the care of a qualifying individual although the camp specializes in a particular activity.
Overnight camps are not employment related expenses.
The cost of a day camp or similar program which specializes in a particular activity may be considered an employment related expense.
The cost of transportation to a day camp or to an after-school program not on school premises furnished by a dependent care provider may be an employment-related expense.

Room and Board

Additional costs for a care-provider’s room and board are employment related expenses.

Indirect Expenses

Indirect expenses such as application and agency fees may be employment-related expenses if the taxpayer is required to pay the expenses to obtain the care. However, forfeited deposits and other payments are not for the care of a qualifying individual if care is not provided.

WHAT CAN YOU DO NOW?

The regulations are proposed to apply to taxable years ending after the date the regulations are published as final regulations in the Federal Register. However, plan sponsors can rely on the proposed rules earlier. You should review your plan document and communication material to determine if any changes are required.

Note: This material is for the sole purpose of providing general information and does not under any circumstances constitute legal advice and should not be used as a substitute for legal advice. You should seek the advice of counsel when applying the requirements to your plans.

For more information on this ErisaALERT, contact us by phone at 610-524-5351 and ask for Mary Andersen or 973-994-7539 and ask for Theresa Borzelli.

ErisaALERT 2006-5

DCAP, Dependent care expenses, FSA