Dependent Care FSA for an off calendar year plan.

[Guest Joe Vasko]

If you participate in a Dependent Care FSA with you employer that runs from 10/1/01 to 9/30/02, but do not incurr any expenses until after the first of the year (1/1/02) then how is the amount shown in Box 10 of your W-2 not treated as taxable income on Form 2441, Child and Dependent Care Expenses.

Thanks,

Joe

[papogi]

It is taxable income, and there's no way around it. Page two of form 2441 is designed to isolate that portion of W-2 box 10 that was not used during that tax year. If the amounts were not used, it becomes taxable income on 1040 line 7.

[Guest Joe Vasko]

I don't understand how it can be taxable income, if the Plan allows you to withhold these dollars on a pre-tax basis to pay for eligible dependent care expenses that you incur during the course of the Plan Year (10/1/01 - 9/30/02), even if you didn't incur them during the calendar year in question.

[papogi]

Regardless of the dates of the Section 125 plan year that an employer has, the IRS follows a calendar year for reporting purposes. Since the employee incurred no expenses in 2001, any amounts contributed to a DCFSA in 2001 will be taxable following the instructions for form 2441. Say the employee elected the full $5000, and expects the $5000 to be spread out from 1/1/02 to 9/30/02, but must elect it as of 10/1/01, per their plan year. The portion deducted from 10/1/01 to 12/31/01 (box 10 on the 2001 W-2) will end up being taxable, since no services were incurred during that time. When they go to do their 2002 taxes, the amount in box 10 will be around $4100 ($5000 minus the amount deducted from 10/1/01 to 12/31/01). The employee has $5000 worth of claims from 1/1/02 to 9/30/02. When they fill out the 2002 form 2441, they can then get the credit for the amount that exceeds $4100, subject to limits. They lost the pre-tax benefit for that amount on their 2001 taxes, but got it back on their 2002 taxes. It will all basically come out even in the end. But, following the rules, that's how it will need to be done.

[Guest aearle]

I have a similar issue, but with an added twist:

An employee is divorced. She and her husband have a son, who (according to the divorce agreement) each gets to claim as a dependent on their taxes returns in alternating years. The employee's company has an off-calendar year plan (8/1/02-7/31/03). So for part of the plan year, 8/1/02-12/31/02, she will not be claiming the son as her dependent -- BUT she does pay every month of every year towards his daycare. Then from 1/1/03-7/31/03 the son will be her tax dependent. She does not want to have money taken out of her paycheck through the DCFSA until January. It is my understanding that she has to have the money taken out of her check evenly across the entire plan year. Or, can she wait until 1/1 to join the FSA and only have money taken out for the remainder of the plan year? Also, since she is paying for her son's daycare during the later part of 2002 (even though he is not her tax dependent for 2002), can she get reimbursed during this time period? She is very frustrated that she is locked into a plan year that does not coincide with the calendar year -- plus she has this funky tax dependent situation. Help!! Thanks!

[papogi]

Regardless who gets the exemption for tax purposes, a qualified individual for the child/dependent care credit or a dependent care account must live with the taxpayer for over half the year. Even though both parents get the exemption, only the parent with whom the child lives for more days than the other gets the ability to get the child care credit or have a dependent care account. Incidentally, a health care account does not work that way. Under the situation you described, both parents could have a health care account and be reimbursed for expenses incurred by the child.

[Guest MarcieMcA]

Regarding Joe's original question, does this apply to medical flex spending accounts as well? If the plan year is from 10/01 to 9/30 but the participant does not start incurring medical expenses until January, will the money put into the FSA for Oct, Nov and Dec be taxable?

[papogi]

HCFSA's do not have this same rule. Both parents can have HCFSA's and have expenses reimbursed on the child independently of one another. In other words, each parent can have their share of medical expenses reimbursed through their own HCFSA, regardless who gets the exemption or who the child lives with primarily.

[Guest MarcieMcA]

I think I may have phrased the question incorrectly. If an employee with a medical FSA has a plan year of 10/01/02 to 9/30/03 but they do not incur any medical expenses for 2002, will the money that they contribute to the medical flex spending account in Oct, Nov and Dec be taxed? Thanks.

[papogi]

Sorry, I misunderstood. The answer to your question is No. Amounts deducted for DCSA's are sometimes taxable in situation such as this because the taxpayer must reconcile all dependent care amounts on Form 2441 (they have to have DC expenses for the amount removed for DC purposes to remain untaxed). There is no such form for health care purposes. Whatever is removed from an employee's paycheck for HCFSA purposes remains untaxed whether any reimbursement is ever asked for. Let me know if this doesn't address your question.

[Guest MarcieMcA]

Thanks Papogi. That is what I assumed but wanted to make sure.

[Guest aearle]

With regard to the original question regarding off-calendar year DCSA where part becomes taxable in 2001...

Is it possible to have 2 different plan years under 2 different Sec 125 plans: one premium only for medical, dental, etc. and one for flexible spending accounts?? It seems with the calendar v. off-calendar year issues related to DCSA that a calendar-year plan is by far the best way to go.

[papogi]

You can have different plan years, one for the premium conversion portion, and another for the FSA's. There are other recent threads which outline some problems with this, however, and points are brought up by many people. One big issue relates to the plan year of the underlying health plans. Since cost change provisions of 125 do not relate to HCFSA's, when employees are making their new health elections and you are also potentially raising their contribution levels, they cannot make a corresponding increase in their HCFSA's since those elections are made at another time. For ease of deductible tracking and how it relates to HCFSA's, and for ease of Form 2441 preparation by your DCSA participants, all plan years (underlying plans, 125 plan, FSA's) really should be calendar. If they're not currently, I would look into changing them.