Dependent Care FSA - End of Year Determination of Qualifying Child

[radiusx2]

If you are a divorced parents, then in most cases, the determination of whether a child qualifies depends on whether the child spends more nights with you than the other parent.  This determination is made at the end of the year.  So if you expect to have the child for more nights and contribute to and get reimbursed from a Dependent Care FSA during the year, and only in December do you realize that the other parent will have one or more nights than you, what rules apply?

[Opus 17]

Then the expenses are non-qualified.  The reimbursements you received are added back to your taxable income, but there is no additional penalty. 

[radiusx2]

You don't cite an authority for your answer.  Also, there seems to be a risk that if the company is notified that all of the reimbursements are not qualified under the plan, the company will request repayment of the reimbursements.  So if that is done, not only will the company adjust the W-2, but the employee will lose the funds.

[Opus 17]

@radiusx2 

Well, you can start by reading IRS publication 503, and look at form 2441 and its instructions.

https://www.irs.gov/publications/p503

You would also have to read publication 15-A on employee fringe benefits.  

The employer who offers the plan, or the plan administrator that they choose to run the plan, is required to do due diligence to ensure that reimbursements are qualified before they pay them. In most cases, that means that the plan administrator must have a receipt listing the name and address of the care provider, the name of the qualifying child, and they may possibly want to see the care provider’s W-10 form.  The plan administrator is not required to verify in the beginning of the year that you will claim the child as a dependent at the end of the year. As you state, circumstances can change, particularly with respect to the parents of divorced or separated children. There is no provision for a clawback. Instead, the remedy for taking a reimbursement which is not qualified is that you pay income tax on it.  This is clearly described in the instructions to form 2441, where any unqualified reimbursements are added back to your line one taxable income with a notation “DCB“ next to it as an explanation. Fortunately, Congress did not choose to create a penalty for the situation.

The employer or the plan administrator is not required to take a clawback, because the remedy for an improper reimbursement is covered on the taxpayer’s tax return.  If the plan administrator is sloppy and has a long track record of issuing reimbursements without proper documentation and without doing due diligence, the employer or plan administrator can be penalized, and can possibly even be barred from offering the plan in the future. But since the problem of dependents during divorce or separation is well understood, the plan administrator is not going to face repercussions if they obtained due diligence from the taxpayer and then the taxpayer’s situation changes.