Tax Implications

What are the tax implications of child care subsidies under this program?

The child care subsidies are generally taxable as income to the employee who benefits from them (26 U.S.C. § 61 and 26 CFR § 1.61-1). Employees are encouraged to seek advice related to tax liability from their financial advisors.

Are the subsidies eligible for any type of tax exemption?

Yes, under certain conditions. The IRS has advised us that if an agency implements the child care subsidy program as a dependent care assistance program, described in section 129 of the Internal Revenue Code (Code), amounts of up to either $2,500 or $5,000 may be excluded from gross income.

To qualify for the exclusion, an employee must claim the child as a dependent on the employee’s Federal income tax return. A disabled child must meet the definition located in 26 CFR 1.44A-1(b)(4) to qualify for the exemption.

Are agencies required to develop a Dependent Care Assistance Plan (DCAP)?

OPM strongly recommends all agencies to develop a DCAP. To obtain further guidance on the tax implications of DCAP, agencies may call the IRS, Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations), at (202) 622-6080 or on the IRS website, http://www.IRS.gov.

Where can agencies obtain more information about setting up the child care subsidy as a dependent care assistance program?

The requirements of a DCAP are outlined in section 129 of the Code. There are also several reporting requirements that are imposed under this section. IRS Publication 503 describes those requirements and can be found at http://www.irs.gov/pub/irs-pdf/p503.pdf . Agencies may obtain further guidance by calling the IRS, Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations), at (202) 622-6080 or on the IRS website, http://www.IRS.gov. A sample DCAP is also included in this guide under Appendix I.

How can employees ensure that they are calculating their exemptions correctly?

Please refer to Publication 503 “Child and Dependent Care Expenses.” You should also consult your tax advisor to be sure that you calculated the child care credits and exemptions correctly.