On May 10, 2021, the IRS released an advance version of Notice 2021-26 to provide clarification regarding the taxability of benefits received in 2021 and 2022 under a dependent care assistance program (DCAP) that allows for carryovers or extended grace periods.


Passage of the Consolidated Appropriations Act, 2021, in December 2020, permitted DCAPs to carry over unused benefits from plan years ending in 2020 to the plan year ending in 2021 as well as from plan years ending in 2021 to the plan year ending in 2022. In addition, DCAPs that provide for a grace period for plan years ending in 2020 or 2021 are allowed to extend that grace period from 2.5 months to 12 months following the end of the plan year.

However, the CAA did not increase the Section 129 income tax exclusion, which excludes DCAP benefits from gross income when they are paid or reimbursed, not when they are contributed. This was remedied by the American Rescue Plan Act of 2021 (ARPA), which temporarily increased the exclusion (for 2021 only) to $10,500 for single and married/filing jointly taxpayers and $5,250 for married/filing separately taxpayers.

IRS Notice 2021-15, released on February 18, 2021, provided that unused DCAP benefits carried over from prior years or available during an extended period for incurring claims are not taken into account in determining the annual limit applicable for the following year. Notice 2021-15 clarified that DCAP participants may continue to make maximum allowable plan limit contributions even if they had unused funds that carried over or have benefited from an extended grace period.

IRS Notice 2021-26

Notice 2021-26 provides that “DCAP benefits that would have been excluded from income if used during the taxable year ending in 2020 or 2021, as applicable, remain eligible for exclusion from the participant’s gross income and are disregarded for purposes of application of the limits for the subsequent taxable years of the employee when they are carried over from a plan year ending in 2020 or 2021, or permitted to be used pursuant to an extended claims period.” Therefore, for taxable years ending in 2021 and 2022, all funds in a DCAP resulting from the new carryover provision or an extended grace period will continue to be excluded from an employee’s gross income and are not to be considered “wages” of the employee.

In addition, Notice 2021-26 provides examples that illustrate the potential tax consequences of electing the ARPA-provided $10,500 in DCAP benefits for non-calendar-year plans.