Dependent care carryovers not taxable, explains IRS

If employees roll over money for dependent care expenses, Payroll won’t have to withhold taxes on it.

That comes straight from the source in IRS Notice 2021-26.

Dependent care benefits that would’ve been excluded from income if used during taxable year 2020 (or 2021)? They will remain excludable from gross income and don’t count as employee wages for 2021 and 2022.

The Taxpayer Certainty and Disaster Tax Relief Act of 2020 let employers amend their plans to permit the carryover of unused dependent care assistance program amounts to plan years ending in 2021 and 2022.

New dependent care limits for 2021

Remember that the American Rescue Plan Act raised limits significantly for this year. The 2021 dependent care limits:

• $10,500 for single taxpayers and married individuals filing jointly (up from $5,000), and
• $5,250 for married individuals filing separately (previously $2,500).

Note: These changes don’t apply to healthcare FSAs at all. That contribution limit remains unchanged at $2,750.

These new higher limits may offer an unexpected benefit. They can encourage reluctant employees to return to work, says Cynthia Cox, VP at Kaiser Family Foundation, a health research group.

When you consider that 81% of employees either don’t want to return to the office or prefer a hybrid arrangement, you need every incentive you can get!