Section 129 (DCAP) W-2 reporting for failed test

[Jewels0110]

Hello all,

I started a new job, and my team has told me that we failed section 129 non-discrimination test last year and made the appropriate adjustments prior to the end of the plan year. But they have told me that the W-2s still reflected the full election/contribution amount and not adjusted for the amounts that were considered taxable therefore added as imputed income. I just spoke Payroll, and they said this is how it should be done. But I have also read that only the amount considered pre-tax (tax favored) should be reported on the W-2 box 10. Does anyone know what is correct or is either fine as long as the imputed income is reflected correctly for the plan year?

Thank you!

[Brian Gilmore]

I think the employer is confusing the rules here.  While it is true that Box 10 includes both taxable and non-taxable dependent care assistance amounts, the non-taxable component is for amounts in excess of the $5k tax-free limit.  

In your case, the reductions to your account brought you below the $5k limit to (presumably) pass the 55% average benefits test.  Those reductions resulted in the excess amounts simply being converted to taxable income you could use for any purpose.  That excess amount returned to you as taxable income was no longer dependent care assistance.  It was simply taxable cash that should be reported in Box 1, 3, 5.  It wouldn't be reported in Box 10.

• More details: https://www.newfront.com/blog/the-dependent-care-fsa-average-benefits-test

IRS Publication 15-B:

https://www.irs.gov/pub/irs-pdf/p15b.pdf

Form W-2.

Report the value of all dependent care assistance you provide to an employee under a DCAP in box 10 of the employee's Form W-2. Include any amounts you can't exclude from the employee's wages in boxes 1, 3, and 5. Report in box 10 both the nontaxable portion of assistance (up to $5,000) and any assistance above that amount that is taxable to the employee.

Example.

Oak Co. provides a dependent care assistance FSA to its employees through a cafeteria plan. In addition, it provides occasional on-site dependent care to its employees at no cost. Emily, an employee of Oak Co., had $4,500 deducted from Emily’s pay for the dependent care FSA. In addition, Emily used the on-site dependent care several times. The fair market value of the on-site care was $700. Emily's Form W-2 should report $5,200 of dependent care assistance in box 10 ($4,500 FSA plus $700 on-site dependent care). Boxes 1, 3, and 5 should include $200 (the amount in excess of the nontaxable assistance), and applicable taxes should be withheld on that amount.