Question: What happens to employees’ dependent care FSA benefits when they go on a leave of absence?

Short Answer: Unlike the health FSA, there are no FMLA continuation of coverage rights for the dependent care FSA because it is not a group health plan. Employees generally will also not have any reimbursable day care expenses during the period of leave because those expenses will not be work-related.

Dependent Care FSA is Not a Group Health Plan Subject to Continuation Rights

Dependent care FSAs are not group health plans. Therefore, unlike with health FSAs, the FMLA and other protected leave law rights to continue group health plan coverage do not apply to the dependent care FSA.

• For more details: Health FSA for Employees on Leave

The result is that the standard dependent care FSA rules and plan terms (as described below) will govern during a period of leave.

Daycare Expenses Incurred During Leave Generally Not Reimbursable

Employees’ dependent care expenses are eligible for reimbursement under the dependent care FSA if they are “employment-related,” which means they must enable the employee (and spouse if married) to be gainfully employed. The IRS summarizes this rule as a requirement the expenses be “work-related” by allowing the employee and (if applicable) to work or actively look for work.

Dependent care expenses incurred during a leave are not for the purpose of allowing the employee and (if applicable) spouse to be gainfully employed by working or actively looking for work while the dependents are in daycare. In other words, such expenses do not qualify as “employment-related” because, by definition, an employee on leave is not gainfully employed. Therefore, in most leave situations, any dependent care expenses incurred by the employee during the period of an employee’s or spouse’s leave will not be reimbursable under the dependent care FSA.

Example #1:

• Steve Trevor enrolls in the dependent care FSA with his company Intelligence Co.

• He goes on leave for the months of June, July, and August after suffering injuries caused by a plane crash.

Result #1:

• Any daycare expenses incurred during June, July, or August are not reimbursable by the dependent care FSA because Steve is not gainfully employed during that period.

Same Result When the Spouse is on Leave

If the employee is married, dependent care expenses will qualify as employment-related only if the spouse is:

• Gainfully employed;

• In active search of gainful employment;

• A full-time student; or

• Mentally or physically incapable of self-care (with the same principal place of abode as the employee for more than half the year).

Accordingly, married employees who are actively at work will nonetheless not have reimbursable dependent care FSA expenses when their spouse is on leave because the spouse must also be gainfully employed.

Example #2:

• Diana Prince enrolls in the dependent care FSA with her company Themyscira, Inc.

• Diana’s husband Steve goes on leave for the months of June, July, and August after suffering injuries caused by a plane crash.

• Diana remains actively at work with Themyscira during the period of her husband Steve’s leave.

Result #2:

• Any daycare expenses incurred during June, July, or August are not reimbursable by Diana’s dependent care FSA because her husband Steve is not gainfully employed during that period.

The “Incapable of Self-Care” Exception for the Spouse Rarely Applies

Dependent care expenses will qualify as employment-related if a married employee is gainfully employed and the spouse is mentally or physically incapable of self-care (with the same principal place of abode as the employee for more than half the year). The test for whether an individual is incapable of self-care presents a higher bar than a standard disability determination for other purposes, such as for short-term disability plan benefits.

An individual is considered physically or mentally incapable of self-care only if, as a result of a physical or mental defect, the individual is incapable of caring for his or her hygiene or nutritional needs, or requires the full-time attention of another person for the individual’s own safety or the safety of others. The IRS summarizes this standard as “Persons who can’t dress, clean, or feed themselves because of physical or mental problems.”

Regulations further confirm that the inability of the individual to “perform the normal household functions of a homemaker or care for minor children by reason of a physical or mental condition does not of itself establish that the individual is physically or mentally incapable of self-care.”

In the parental leave context, a spouse who has just given birth is disabled from working and will be eligible for disability benefits. The employee/spouse therefore cannot continue to incur reimbursable daycare expenses during the leave period unless the spouse’s disability rises to this stricter “incapable of self-care” standard. Most new birthing mothers don’t meet this definition despite being considered disabled for multiple other purposes (FMLA, PDL, SDI, STD, etc.).

• For more details: Dependent Care FSA During Parental Leave

Example #3:

• Diana Prince makes a $2,500 election for the calendar plan year dependent care FSA at open enrollment with her company Themyscira, Inc.

• Diana’s husband Steve makes a $2,500 election for the calendar plan year dependent care FSA at open enrollment with his company Intelligence Co.

• Diana goes on maternity leave for the months of June, July, and August (partially for disability, partially for new child bonding) after giving birth to her daughter Lyta.

• Steve continues to work at Intelligence Co. during Diana’s leave period.

Result #3:

• Any daycare expenses incurred during June, July, or August are not reimbursable by Diana’s dependent care FSA because Diana is not gainfully employed during that period.

• Any daycare expenses incurred during the leave period are also not reimbursable by Steve’s dependent care FSA because both the employee and spouse must be gainfully employed to have eligible “employment-related” expenses.

• Diana’s period of disability following the birth does qualify for the “incapable of self-care” exception because she is still able to dress, clean, and feed herself.

The Two-Week Temporary Absence from Work Exception

Employees who are away from work temporarily for a short, temporary absence are still considered to be gainfully employed and therefore have eligible “employment-related” daycare expenses. The IRS considers an absence of two weeks or less to be a short-temporary absence.

For example, a short PTO period of two weeks or less for vacation or because of an illness qualifies for this exception. However, a longer period away from work such as the typical leave of absence (or summer break for school workers) does not qualify for this exception.

• For more details: Dependent Care FSA During Summer Break

When Are Dependent Care FSA Expenses Considered Incurred?

A dependent care FSA may not reimburse an expense before it is incurred. For these purposes, a dependent care expense is considered “incurred” when the care is fully provided for the service period.

In other words, the dependent care expense is not incurred when the employee is billed, charged, or pays for the dependent care. Rather, the expense is incurred (and therefore reimbursable) only when the actual service has been fully performed (e.g., the end of the month for most daycare providers).

Accordingly, dependent care expenses pre-paid prior to the leave (e.g., daycare, after-school, summer camp) are not eligible for reimbursement if the actual care services are provided during the period of leave.

For more details:

• When FSA Expenses Are Incurred

• Dependent Care FSA Debit Card Substantiation

• Dependent Care FSA During Summer Break

Dependent Care FSA Contributions Will Cease During an Unpaid Leave

In an unpaid leave, the employee will not have compensation through payroll to permit pre-tax contributions to continue. Accordingly, dependent care FSA contributions will cease for the period of unpaid leave.

The cafeteria plan permitted election change event regulations specifically permit employees to revoke their election upon commencement of an unpaid leave of absence affecting eligibility, and re-establish (or modify) the election upon return from the unpaid leave of absence affecting plan eligibility. Upon return from unpaid leave, employees may therefore choose to reinstate their dependent care FSA election as in effect prior to the leave, keep their election revoked as it was during the leave, or make a new election increasing or decreasing their dependent care FSA election that was in place prior to the leave.

There is some question as to whether employers could—for purposes of the dependent care FSA—rely on the same group health plan contribution rules that permit employees to pre-pay pre-tax contributions on the final payroll(s) prior to the leave, pay-as-you-go contributions (with after-tax dollars where the leave is unpaid) during the leave, or make a catch-up payment on the initial payroll(s) upon return from leave with respect to the health FSA. However, the cafeteria plan FMLA rules specifically refer to these options only in the context of continuing coverage during the leave period (which is inapplicable to the dependent care FSA) and only with respect to group health plans and the health FSA. Therefore, employers are better served by simply following the general cafeteria plan election change rules in this context.

Employees May Be Able to Continue Contributing to Dependent Care FSA During Paid Leave

The plan terms will generally deem as ineligible any daycare expenses incurred during the employee’s leave period (because they are not considered employment-related). Nonetheless, if the plan terms permit, employees on a paid leave can continue to participate in the dependent care FSA during the leave by making contributions—despite being unable to incur any reimbursable expenses during that period.

There is some question as to whether an employee on paid leave is able to revoke the dependent care FSA contribution election during the period of leave. The cafeteria plan permitted election change event regulations specifically address only unpaid leaves as a basis for changing elections.

However, employers can reasonably take the position that the employee has experienced a change in employment status causing the loss of eligibility for the dependent care FSA by virtue of being unable to incur claims during the leave period. This should qualify as a change in status permitted election change event. Furthermore, the permitted election change event rules are far less restrictive for the dependent care FSA than most other benefits, and therefore it is relatively easy in any scenario for employees to find a basis upon which to change their dependent care FSA election.

• For more details: Dependent Care FSA Election Changes

Employees on paid leave can continue dependent care FSA contributions because they maintain the ability to contribute pre-tax through payroll for compensation received during the leave period. Employees offered a choice often will make the decision to continue dependent care FSA contributions while on leave—even though they cannot incur any eligible expenses during that period. This allows the employee to a) fund claims that were already submitted prior to the leave in excess of year-to-date contributions, or b) have those additional tax-advantaged funds available to reimburse daycare expenses upon return to work.

Where employees choose not to contribute to the dependent care FSA during the leave, or the plan terms prohibit contributions during the leave period, employees will generally return to their pre-leave election. For example, if the employee’s dependent care FSA election was for the $5,000 maximum, the employee will have an increased per-payroll contribution for the remainder of the plan year to reach the full election by making up for the period of missed contributions during the leave.

What About When the Employee’s Spouse is On Leave?

Where the employee’s spouse is on leave, the employee generally is not able to incur reimbursable daycare expenses because those expenses are not considered employment-related unless they enable both the employee and spouse to work. However, both the employer and FSA TPA generally will not be aware of the spouse’s leave and the fact that the employee is unable to incur reimbursable expenses.

• For more details: Dependent Care FSA During Parental Leave

In that case, the employee will typically always have the ability to continue dependent care FSA contributions, but the employee will be solely responsible for understanding that any expenses incurred during that period will not be reimbursable.

Determining Eligible Dependent Care FSA Expenses

Ultimately, the determination as to whether the employee’s daycare expenses are eligible for reimbursement under the dependent care FSA is an individual income tax issue to be resolved by the employee. Where in question, employees should consult a personal tax advisor for assistance in determining whether their expenses are eligible for dependent care FSA reimbursement.

The dependent care FSA’s third-party administrator will require the employee to certify that the expenses are eligible for reimbursement upon submitting a claim. However, unless the administrator has reason to believe that an expense does not qualify for reimbursement, there will be no further inquiry made by the administrator. The employee is responsible for verifying the eligible expenses on the individual tax return (IRS Forms 1040 and 2441), and if ever raised on audit of the individual tax return by the IRS.

Reminder: Health FSA is a Group Health Plan Subject to Continuation Rights

Employers must permit employees to maintain group health plan coverage for an employee on FMLA leave in the same manner as if the employee were active. Employees have the right to elect to continue coverage or revoke it for the leave period. (Many states also have similar protected leave laws that guarantee employees the same rights to continue group health plan coverage where FMLA does not apply.)

The health FSA is a group health plan. When an employee goes on FMLA leave (or a state protected leave offering similar rights), the employee has the right to continue or revoke health FSA coverage during the period of the leave in the same manner as medical, dental, vision, and any other form of group health plan coverage.

• For more details: Health FSA for Employees on Leave

Relevant Cites:

Treas. Reg. §1.125-3, Q/A-7:

Q-. 7. Are employees entitled to non-health benefits while taking FMLA leave?

A- 7. FMLA does not require an employer to maintain an employee's non-health benefits (e.g., life insurance) during FMLA leave. An employee's entitlement to benefits other than group health benefits under a cafeteria plan during a period of FMLA leave is to be determined by the employer's established policy for providing such benefits when the employee is on non-FMLA leave (paid or unpaid). See 29 CFR 825.209(h). Therefore, an employee who takes FMLA leave is entitled to revoke an election of non-health benefits under a cafeteria plan to the same extent as employees taking non-FMLA leave are permitted to revoke elections of non-health benefits under a cafeteria plan. For example, election changes are permitted due to changes of status or upon enrollment for a new plan year. See §1.125-4.

Treas. Reg. §1.125-4(c)(2):

(iii) Employment status. Any of the following events that change the employment status of the employee, the employee's spouse, or the employee's dependent: a termination or commencement of employment; a strike or lockout; a commencement of or return from an unpaid leave of absence; and a change in worksite. In addition, if the eligibility conditions of the cafeteria plan or other employee benefit plan of the employer of the employee, spouse, or dependent depend on the employment status of that individual and there is a change in that individual's employment status with the consequence that the individual becomes (or ceases to be) eligible under the plan, then that change constitutes a change in employment under this paragraph (c) (e.g., if a plan only applies to salaried employees and an employee switches from salaried to hourly-paid with the consequence that the employee ceases to be eligible for the plan, then that change constitutes a change in employment status under this paragraph (c)(2)(iii)).

Treas. Reg. §1.21-1(b):

(4) Physical or mental incapacity. An individual is physically or mentally incapable of self-care if, as a result of a physical or mental defect, the individual is incapable of caring for the individual's hygiene or nutritional needs, or requires full-time attention of another person for the individual's own safety or the safety of others. The inability of an individual to engage in any substantial gainful activity or to perform the normal household functions of a homemaker or care for minor children by reason of a physical or mental condition does not of itself establish that the individual is physically or mentally incapable of self-care.

Treas. Reg. §1.21-1(c):

(c) Gainful employment.

(1) In general. Expenses are employment-related expenses only if they are for the purpose of enabling the taxpayer to be gainfully employed.

…

(ii) Exception for short, temporary absences. A taxpayer who is gainfully employed is not required to allocate expenses during a short, temporary absence from work, such as for vacation or minor illness, provided that the care-giving arrangement requires the taxpayer to pay for care during the absence. An absence of 2 consecutive calendar weeks is a short, temporary absence. Whether an absence longer than 2 consecutive calendar weeks is a short, temporary absence is determined based on all the facts and circumstances.

IRS Tax Topic No. 602:

Physically or Mentally Not Able to Care for Oneself - An individual is physically or mentally incapable of self-care if, as a result of a physical or mental defect, the individual is incapable of caring for his or her hygiene or nutritional needs or requires the full-time attention of another person for the individual's own safety or the safety of others.

Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues. This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship. Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).