What Is DCSFA and How Does It Work for Dependent Care Expenses?

Paying for child or dependent care can be a major expense, especially for working parents and caregivers. To help offset these costs, some employers offer a Dependent Care Flexible Spending Account (DCSFA), which allows employees to set aside pre-tax dollars for eligible care expenses.

Understanding how a DCSFA works is essential for making the most of its benefits.

Contribution Limits

The IRS sets annual limits on DCSFA contributions. For 2024, the maximum is $5,000 per household for individuals or married couples filing jointly. Those married but filing separately can contribute up to $2,500 each. These limits apply per household, so spouses with separate DCSFAs cannot each contribute $5,000.

Employers may impose lower limits, so employees should check with their benefits administrator. Contributions are deducted in equal installments throughout the year. Once set during open enrollment, changes are generally only allowed after a qualifying life event, such as marriage, divorce, or the birth of a child.

Unused funds do not roll over. If contributions are not used by the plan’s deadline—typically December 31 or a grace period extending to March 15 of the following year—the remaining balance is forfeited. Some employers provide a short run-out period, usually 90 days, to submit claims for expenses incurred before the deadline.

Eligible Dependents

A DCSFA can only be used for dependents who meet IRS eligibility criteria. This includes children under 13 and individuals who are physically or mentally incapable of self-care and live with the account holder for more than half the year. The dependent must also be claimed on the account holder’s tax return.

For parents with shared custody, only one parent can claim a child as a dependent for DCSFA purposes. If both contribute to separate DCSFAs, only the parent claiming the child on their tax return can use their funds. For adult dependents, such as an elderly parent with a disability, they must live in the same household and require assistance with daily activities like bathing or eating.

Qualifying Expenses

DCSFA funds can only be used for care expenses that enable the account holder to work or seek employment. Eligible expenses include payments to daycare centers, babysitters, nannies, and before- or after-school programs. The care provider cannot be a spouse, the child’s parent, or another dependent on the account holder’s tax return.

Summer day camps qualify, but overnight camps do not. In-home care services, such as hiring a nanny through an agency, are eligible but come with additional tax reporting requirements. If a caregiver is considered a household employee, the employer must comply with IRS tax rules, including issuing a Form W-2 and paying Social Security and Medicare taxes if wages exceed $2,700 in 2024. Payments made without proper documentation cannot be reimbursed.

Reimbursement Process

To receive reimbursement, participants must submit proof of payment and documentation confirming that the expense qualifies under IRS guidelines. Employers typically require an itemized receipt or invoice from the care provider, which should include the provider’s name, address, taxpayer identification number (TIN) or Social Security number, dates of service, and the amount charged. If a provider refuses to supply a TIN, the request may be denied unless the participant can demonstrate a reasonable effort to obtain it, as outlined in IRS Form W-10 instructions.

Some employers offer a debit card linked to the DCSFA, allowing direct payment for expenses. While convenient, transactions are subject to audit, and participants may need to provide additional documentation. If an expense is later deemed ineligible, the account holder must repay the amount or face potential tax penalties.

Tax Considerations

A DCSFA provides tax savings by allowing pre-tax contributions, reducing taxable income. However, it’s important to understand how these savings interact with other tax benefits, particularly the Dependent Care Tax Credit (DCTC).

Interaction with the Dependent Care Tax Credit

Expenses reimbursed through a DCSFA cannot also be claimed for the Dependent Care Tax Credit. The tax credit allows taxpayers to claim a percentage of up to $3,000 in expenses for one dependent or $6,000 for two or more. The percentage ranges from 20% to 35%, depending on adjusted gross income (AGI), with the highest benefit available to those earning $15,000 or less.

Since the DCSFA allows up to $5,000 in pre-tax contributions, higher earners often benefit more from using the account, as the tax savings typically exceed the credit’s value. However, if dependent care costs exceed $5,000, additional eligible expenses may still be claimed under the tax credit, up to the allowable limit.

Impact on Social Security and Medicare Taxes

Because DCSFA contributions reduce taxable wages, they also lower earnings subject to Social Security and Medicare taxes. While this provides immediate savings, it can slightly reduce future Social Security benefits, as benefits are calculated based on lifetime taxable earnings. For high-income earners, this impact is minimal, but for lower-wage earners, it’s worth considering. Additionally, since DCSFA contributions are exempt from federal income tax, they also reduce state income tax liability in most states, though some, such as New Jersey and Pennsylvania, do not exclude these contributions.