IRS Provides Favorable Tax Ruling on Increased Dependent Care Reimbursement Accounts

Last year’s year-end Consolidated Appropriations Act (CAA) provided that, at the employer’s discretion, a Dependent Care Reimbursement Account (DCRA) could allow unused funds from a plan year ending in 2020 to be rolled over to a plan year ending in 2021, and for unused funds from a plan year ending in 2021 to be rolled over to a plan year ending in 2022. Then, the American Rescue Plan Act of 2021 (ARPA) allowed an employer to temporarily increase the limit for a DCRA from $5,000 to $10,500 for calendar year 2021 only (see our blog article describing that here). That is, if an employer so allowed, a plan participant in a flexible spending account with a DCRA could be reimbursed up to $10,500 in 2021 for that year’s election and any unutilized 2020 carryover funds. And that participant could carryover any unused DCRA amounts from 2021 into 2022 and add it to his regular 2022 election of up to $5,000. But a potential tax hurdle remained.

Specifically, if a participant was allowed to carryover unused DCRA funds from 2020 to 2021, and from 2021 to 2022, and then was reimbursed for eligible expenses exceeding $10,500 in calendar year 2021 or $5,000 in calendar year 2022, the Acts failed to address the fact that the annual allowable excludable limit for actual reimbursements from a DCRA on an employee’s individual tax return was still $10,500 for 2021 and $5,000 for 2022.

On May 10, 2021, the IRS solved these problems with Notice 2021-26. In that Notice, first the IRS explained that under IRS Notice 2021-15, the employer had the optional ability to carryover and extend unused DCRA funds from plan years ending in either 2020 or 2021 to the next plan year. Next, the Notice recognized that ARPA had provided the employer the ability to optionally increase the limit for DCRA reimbursements for the calendar year to $10,500 for 2021 and 2022. Combining both the carryover/extension of unused DCRA contributions and the increased limits for 2021 and 2022 meant that a participant could in fact have significantly more than $10,500 reimbursed during either or both calendar years 2021 and 2022.


Betty Boop is covered by a calendar year Section 125 cafeteria plan that offers a DCRA benefit. Betty elected to contribute $5,000 to the DCRA for the 2020 plan year but incurred no dependent care expenses during that plan year. Betty’s employer’s plan allows her to carryover the unused $5,000 of DCRA benefits to the 2021 plan year. Betty elects to contribute $10,500 to the DCRA for the 2021 plan year. Betty incurs $15,500 in eligible dependent care expenses in 2021 and is reimbursed $15,500 by the DCRA. The $15,500 is excluded from the Betty’s gross income because $10,500 is excluded as 2021 benefits and the remaining $5,000 is attributable to a carryover permitted under the Act.

It’s a bit more complicated for a non-calendar year plan, since the temporary excludable limits under a DCRA are based on a calendar year.

It’s important to note too that unlike a health care flexible spending account, there is no employer risk of an employee being reimbursed for greater than their to-date contributions (and carryover amounts) in a DCRA.

Employer Actions

  1. Determine if your DCRA plan (typically as part of your § 125 cafeteria plan) will allow a carryover of unused benefits from the plan years ending in 2020 or 2021 (or both) to the following plan year.
  2. Decide if you would like to allow the increased benefit election amounts for a plan year ending in 2021 to $10,500 (and $5,250 for employees filing their tax returns separately).
  3. If you decide for either of these, have your plan documents amended, and communicate the change to eligible participants in the plan. Note that even if the plan year has already begun, the plan can allow the employee to make a contribution change mid-year in order to reach these new limits.