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March 31, 2009

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Once upon a time, there was a family-friendly employer. This family-friendly employer provided employees with a calendar year, full-blown cafeteria plan, chock full of health care benefits, group-term life insurance and a dependent care assistance plan (DCAP). This wonderful employer also provided his employees with something called a "Sick Child Plan." The Sick Child Plan was an employer-paid benefit that employees could use when their child was sick and unable to attend daycare or school. Because the children received such good and responsible care when they were ill, their parents were able to come to work and so remain productive. This made the employer smile. The employer was happy and the employees were happy.

Then it happened one day, at the end of the plan year (December 31), that the employer was filling out an employee's W-2. The employer got to Box 10 on the W-2 and paused. The instructions (in pertinent part) stated:

Show the total dependent care benefits under a dependent care assistance program (section 129) paid or incurred by you for your employee. Include the fair market value (FMV) of employer-provided or employer-sponsored day-care facilities and amounts paid or incurred in a section 125 (cafeteria) plan. Report all amounts paid or incurred including those in excess of the $5,000 exclusion.

Did this mean that the employer would have to include in Box 10 the amount paid for the sick child care provided to the employee's child, in addition to the amount of normal daycare expenses reimbursed by the employer under the DCAP in the cafeteria plan? What a record-keeping nightmare! The employer called in his benefits counsel to explain the situation to him.

The benefits counsel told the employer that in order for employer payments under the Sick Child Plan to be excludable from employees' gross income, the plan must conform to '129 of the Internal Revenue Code. Of course, the DCAP provided under the cafeteria plan also was drawn in accordance with '129. As part of complying with '129, no more than $5,000 of employer-provided dependent care services may be excluded during a taxable year, and the plan may not discriminate in favor of highly compensated employees. Thus, employees who were reimbursed the maximum amount ($5,000) in the DCAP under the cafeteria plan and who also used the Sick Child Plan would have exceeded their statutorily permissible exclusion. Those employees would have to take the amount received over $5,000 into income.

In addition, for discrimination testing purposes (i.e., the 55 percent Benefits Test), the employer would have to take into account both plans and the benefits received thereunder. If the plan is found to be discriminatory, those highly compensated employees may have to take into income more than just the excess over $5,000. In a discriminatory plan, highly compensated employees are taxed on the benefits they receive in the plan. On the other hand, if nonhighly compensated employees (who tend not to elect the maximum $5,000) actually use the Sick Child Plan, the receipt of benefits to nonhighly compensated employees may increase, making it easier for the plan to pass discrimination testing (this idea presupposes that some highly compensated employees have "at home" daycare and may not need to use the Sick Child Plan).

To provide an example to the employer of how the record keeping would work, the counsel took a particular nonhighly compensated employee who had elected and was reimbursed $5,000 for childcare provided at the I Luv Children Daycare Center. The employee also on two occasions used the employer's Sick Child Plan and sent the child to the Sick Kids Are Us Center, which cost $360 for the two visits. Thus, the employer had paid a total of $5,360 in dependent care benefits for this employee. So in addition to the $5,000 in box 10, the employer must include $360 in the employee's gross income and include this amount in Boxes 1, 3, 5 and 10 of Form W-2.

The counsel advised the employer that one way to avoid a record keeping nightmare would be to make the Sick Child Plan a taxable benefit plan. This, however, would create a tax disadvantage to those employees who do not elect $5,000 for their DCAP.

Based upon an examination of the overall plans and the participant level in the DCAP, the employer exclaimed, "Record keeping, schmecord keeping! I'm going to do what's right and good for my employees!" And the employees rejoiced and all was well.

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Filed Under: Workplace Issues

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