IRS Finalizes Dependent Care Expense Regulations

September 10, 2007

In August, the IRS issued Final Regulations on what constitutes an eligible expense for purposes of the Dependent Care tax credit and, more importantly for employers, Dependent Care FSAs.

The regulations take immediate effect for the tax credit and can be relied upon currently for Dependent Care FSAs although that effective date is for plan years that start on or after January 1, 2008. The following summarizes the regulations:

• Short, temporary absences. Required dependent care expenses during short-term absences of less than two weeks in duration can be reimbursed if the day care provider requires payment regardless of attendance. In addition, an absence greater than two weeks could also qualify as an eligible expense, based on all the facts and circumstances.
• Camps. Specialty day camps (e.g., soccer or computers) may qualify as dependent care. Any expenses related to overnight camps continue to be prohibited, even if the parent works overnight because overnight camps are strictly prohibited by §21(b)(2)(A) of the Tax Code.
• Summer school and tutoring. These expenses are primarily educational and are not reimbursable.
• Overnight issues. If a parent works a night shift, expenses for overnight care are eligible. Also, if a married couple has one spouse who works during the day and one spouse during the night, day care expenses during the day are qualified expenses.
• Required fees and deposits. If an agency or application fee is required for the provision of day care, that expense is eligible as long as day care is provided. Thus, a parent who pays a $50 deposit to a day care provider but then switches at the last minute may not be reimbursed the $50.
• In-house caregivers. Live-in caregivers are another area that required clarification. The IRS approves these expenses as reimbursable: room, board, increased utilities and any increase in other usual household expenses (e.g., cost of adding another bedroom).
• Online education. Internet degrees are becoming more prevalent. Full-time students meet the requirement of gainful employment for dependent care expenses. As long as the school with the Internet program offers traditional classroom instruction, the parent will be considered gainfully employed.
• Transportation. Many day care providers will offer transportation from the school to the day care facility for after-school care. Those expenses are eligible for reimbursement. However, if the transportation is provided by someone else (e.g., a taxi service or public transportation), that expense is not eligible.
• Sick child care. Some children’s hospitals offer a program that allows parents to drop off marginally sick children when the day care provider will not watch them. A fever or flu symptoms are common reasons. Even though it is arguable that the primary purpose is the provision of day care instead of medical care, the IRS refused to permit this expense as eligible.

Infinisource was one of several companies to provide comments to the IRS on the regulations before they were finalized. If you have any questions about dependent care expenses, please feel free to contact our Fringe Benefits team at 800-300-3838.