What expense category is Dependent Care Assistance?

Offering benefits that support employees' work-life balance, such as dependent care assistance, is a powerful way for businesses to attract and retain talent. These programs help employees cover the cost of care for their children or other dependents, allowing them to focus on their work.

For employers, the contributions made to these programs are a deductible business expense. However, to qualify for this deduction, the program must be structured in accordance with specific IRS rules. This guide explains how to categorize dependent care assistance expenses, outlines the requirements for a qualifying plan, and provides guidance on tracking these contributions for tax purposes.

Dependent Care Assistance Expense Category

Employer contributions to a dependent care assistance program are considered an employee benefit program expense. According to IRS Publication 535, Business Expenses, amounts an employer spends on these programs are generally deductible as an ordinary and necessary business expense.

On a company's books, these costs should be recorded in a specific account, such as Employee Benefits or Dependent Care Assistance, to distinguish them from regular wages and other forms of compensation.

Important Considerations When Classifying Dependent Care Assistance

To ensure the deductibility of your contributions and the tax-free status for your employees, your program must be a formal, qualified plan.

What is a Qualified Dependent Care Assistance Program?

A dependent care assistance program must be a written plan established for the exclusive benefit of your employees. Key requirements include:

• The benefits must be available to all eligible employees.
• The plan cannot favor highly compensated employees or owners.
• You must provide reasonable notification of the plan's availability and terms to all eligible employees.

Tax Benefits for Employer and Employee

When a program is qualified, it offers a dual tax advantage:

• For the Employer: The contributions you make to the plan are a deductible business expense.
• For the Employee: The assistance your employee receives is non-taxable to them, up to certain annual limits established by the IRS. This means the value of the benefit is excluded from their gross income and is not subject to social security or Medicare taxes.

Distinction from the Employee's Tax Credit

It is essential for employers to recognize that providing dependent care assistance through an employee benefit plan is distinct from the Child and Dependent Care Credit that an employee may claim on their personal tax return (Form 1040). An employee cannot use the same expenses to receive tax-free benefits from an employer's plan and claim the tax credit.

Examples of Dependent Care Assistance Expenses

Employer contributions can take several forms, all of which are deductible if part of a qualified plan:

• Direct Payments: The employer pays a daycare center or other care provider directly on behalf of the employee.
• Employee Reimbursements: The employee pays for dependent care and submits proof of the expense to the employer for reimbursement.
• On-site Daycare Facility: The employer operates a daycare facility on its premises for the children of employees. The costs of operating this facility, such as staff salaries, utilities, and supplies, are deductible expenses.

Tax Implications and Recordkeeping

Proper reporting and documentation are essential for deducting these expenses.

How to Report the Deduction

For a sole proprietor filing a Schedule C (Form 1040), contributions to employee benefit programs like dependent care assistance are deducted under Part II, Line 14, Employee benefit programs (other than Pension and profit-sharing plans).

If you operate an on-site facility, individual costs (such as salaries or utilities) are deducted in their respective categories.

What Records to Keep

You must maintain records to prove that your plan is qualified and to substantiate the expenses you deduct. These records include:

• The written plan document.
• Records showing which employees are eligible and which are participating.
• Proof of payments made, whether to a provider or as a reimbursement to an employee. This includes invoices from care providers, receipts submitted by employees, and canceled checks or bank statements.

How Fyle Can Automate Tracking for Dependent Care Assistance

Fyle helps you manage and document dependent care reimbursements, ensuring every payment is compliant and properly recorded.

• Capture Employee Claims: Employees can easily submit receipts from their daycare provider to Fyle for reimbursement.
• Enforce Policy Limits: Set up policies in Fyle to ensure reimbursements do not exceed the annual IRS limits for tax-free assistance.
• Create a Clear Audit Trail: Fyle keeps the employee's submission, the provider's receipt, and proof of reimbursement together in one digital record.
• Automate Your Accounting: Sync categorized expenses directly to your Employee Benefits account in various accounting softwares such as QuickBooks, Xero, NetSuite, or Sage Intacct.