Dependent Care Assistance Program (DCAP)

A Section 125 cafeteria plan benefit letting employees set aside pre-tax dollars (up to $7,500 in 2026) for work-related dependent care like daycare, preschool, and day camps. It can be added to an existing FSA or POP plan document.

See the Step-by-Step ProcessView Templates & Resources

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What Employee pre-tax salary reductions under Section 125 and Section 129 to pay eligible work-related dependent care (e.g., daycare, preschool*, before/after-school programs, day camps). The 2026 annual limit is $7,500 per household ($3,750 if married filing separately), increased from $5,000/$2,500 under the One Big Beautiful Bill effective January 1, 2026. Employers must formally amend their plan documents to offer the higher limit.
Who Employers offering a cafeteria plan; employees with a qualifying person: a child under age 13, or a spouse or dependent of any age who is incapable of self-care and lives with the employee for more than half the year.
When Adopt or amend the plan document before the plan year; employees elect during open enrollment (mid-year changes only for permitted status change events). Run nondiscrimination testing annually, mid-year recommended to allow time for corrections.
Risk If nondiscrimination tests fail under Section 129 or Section 125, highly compensated individuals (HCIs) lose the income exclusion; their DCAP benefits become taxable. Rank-and-file employees are unaffected. Reimbursing ineligible expenses, missing provider TINs, or forfeiting funds past the run-out deadline can also create taxable income for the affected employee.

*Preschool/nursery school is generally eligible when the primary purpose is care, not education. Kindergarten and above is generally not eligible.

Before
Plan year start

Adopt or amend the signed plan document (and DCAP provisions) before the first pre-tax deduction.

$7,500
2026 annual limit

Per household ($3,750 married filing separately). A plan amendment is required to offer the higher limit.

Box 10
W-2 reporting

Report total dependent care benefits annually so employees can complete Form 2441.

Trigger When Notes
Adopt or amend cafeteria plan document + DCAP provisions Before plan year begins Must be signed and dated before the first pre-tax deduction. To offer the new $7,500 limit for 2026, a plan amendment is required before elections at the higher amount are made. If you have an existing FSA or POP plan document, add a DCAP addendum; no separate Section 125 plan needed.
Open enrollment elections Annually (before plan year) Elections are irrevocable for the year unless a permitted status change occurs (birth, adoption, change in care provider, change in employment status, etc.).
Nondiscrimination testing (Section 129 & Section 125) Annually; mid-year recommended Section 129 has four tests specific to dependent care; Section 125 has three as part of the cafeteria plan. No IRS filing required, internal test only. Mid-year testing allows prospective adjustments before year-end if HCIs are over-benefiting.
Claims submission deadline (run-out) Per plan terms (typically 60-90 days after plan year end) No carryovers for DCAP; unused funds forfeit at run-out. A grace period of up to 2.5 months may be offered if specified in the plan document.
W-2 reporting (Box 10) Annually (with W-2 filing) Report total dependent care benefits, both employer contributions and employee pre-tax salary reductions, in Box 10. Employees use this to complete Form 2441.
Trigger: Adopt or amend plan document + DCAP provisions
When: Before plan year begins
Notes: Signed before the first deduction. Add a DCAP addendum to an existing FSA/POP plan; a plan amendment is required for the $7,500 limit.
Trigger: Open enrollment elections
When: Annually (before plan year)
Notes: Irrevocable for the year unless a permitted status change occurs.
Trigger: Nondiscrimination testing (Section 129 & Section 125)
When: Annually; mid-year recommended
Notes: Section 129 has four tests; Section 125 has three. Internal test only.
Trigger: Claims submission deadline (run-out)
When: Typically 60-90 days after plan year end
Notes: No carryovers; unused funds forfeit. A grace period up to 2.5 months may be offered.
Trigger: W-2 reporting (Box 10)
When: Annually (with W-2 filing)
Notes: Report total dependent care benefits in Box 10 for Form 2441.
  • Cafeteria Plan Document + DCAP provisions: The foundational Section 125 written plan document with a DCAP addendum or appendix covering eligibility, the annual limit (update to $7,500 for 2026 if you're adopting the new maximum), run-out period, grace period (if any), claims procedures, substantiation requirements, and forfeiture rules. If you already have an FSA or POP plan document, add the DCAP as a formal written amendment, not a separate plan.
  • Summary Plan Description (SPD): ERISA requires participants to receive an SPD within 90 days of first becoming covered. For most small DCAP plans, the plan document serves as the SPD.
  • Salary Reduction Agreement: A signed pre-tax election from each participant, completed before the plan year or within the new-hire election window. Retain for at least 6 years.
  • Mid-year change documentation: Forms to capture qualifying events (birth, change in provider, change in employment status) that permit a mid-year election change. Document the event, date, and updated election amount.
  • Substantiation process: A claims process requiring provider name/address, service dates, amount, and provider TIN/SSN on every claim, required for IRS compliance and for the employee's Form 2441 filing. Establish this before the first reimbursement.
  • Employee census (for nondiscrimination testing): A roster of all employees with name, hire date, compensation, ownership percentage, officer status, HCI status, and DCAP election amount. Used for both Section 129 and Section 125 tests. See the Templates & Resources section below for the NDT Worksheet reference.
  • Participant communications: Plain-language description of what's eligible, what's not, the annual limit, the run-out deadline, and how to submit claims. Distribute at enrollment.

Part A: Setting Up the Plan

1
Draft or amend the plan documentDefine the annual limit (up to $7,500 for 2026 if adopting the new maximum), run-out period, grace period (if any), eligible expenses, substantiation requirements, and forfeiture rules. If you have an existing Section 125 plan document, add a DCAP addendum as a formal written amendment. The document must be signed and dated before any pre-tax deductions begin.
2
Run open enrollmentCommunicate the DCAP to employees before the plan year. Collect signed salary reduction elections and remind participants that elections are irrevocable; they can change mid-year only for IRS-permitted status change events.
3
Set up payroll deductionsCoordinate with your payroll system to take the correct pre-tax DCAP deductions each pay period. Unlike health FSAs, DCAPs do not have a uniform coverage rule; employees can only be reimbursed up to their account balance at the time of the claim.
4
Operate claimsReimburse only after care services are provided; no prepayments or deposits. Require provider name/address, service dates, amount, and provider TIN/SSN on every claim. Your TPA typically handles this; if self-administering, establish a consistent claim review process before the first payment.
5
Run nondiscrimination testing mid-yearSee Part B below. Mid-year testing gives you time to make prospective adjustments, such as reducing an HCI's election, if a test is at risk of failing before year-end.
6
Close the yearAfter the run-out deadline, forfeit unused funds per the plan document. Issue W-2 Box 10 amounts to all participants (including any employer contributions). Retain all testing workpapers, claims records, and election files.

Part B: Annual Nondiscrimination Testing

DCAPs are subject to two testing frameworks: Section 129 (four tests specific to dependent care) and Section 125 (three tests as part of the cafeteria plan). The Section 125 tests are the same in structure as those for a health FSA: use the Section 125 FSA NDT Worksheet on the FSA page as a starting framework, substituting DCAP election amounts for FSA amounts in the Employee Census. The Section 129-specific tests are run separately:

1
Section 129 Eligibility TestThe DCAP must benefit a classification of employees that is not discriminatory in favor of HCIs. Broad eligibility (all employees, or all employees with a qualifying person) generally passes.
2
Section 129 Benefits & Contributions TestThe plan cannot discriminate in favor of HCIs as to contributions and benefits. Offering the same annual limit and the same reimbursement rules to all participants satisfies this test.
3
Section 129 55% Average Benefits TestThe average DCAP benefit received by non-HCIs must be at least 55% of the average DCAP benefit received by HCIs. This test fails when HCIs max out their elections while non-HCIs elect low amounts or don't participate at all. If at risk, consider broadening participation or adjusting HCI elections prospectively.
4
Section 129 5% Owner LimitNo more than 25% of the amounts paid by the employer under the DCAP may go to employees who are 5%-or-more shareholders or owners. This rarely affects plans with broad participation but can be a problem in closely held businesses.

If any test fails, HCIs lose their Section 129 income exclusion; their DCAP benefits become taxable wages for that year. Rank-and-file employees are not affected. Contact your benefits advisor if a test is failing mid-year; year-end corrections are limited.

  • Work-related care only: The expense must enable the employee (and spouse, if married) to work or look for work. Care while a non-working spouse stays home does not qualify. Exceptions apply when the spouse is disabled or a full-time student.
  • Service period: Reimburse only after care is provided. Advance payments, deposits, and prepayments are ineligible, even if the care provider requires them.
  • Reimbursement limited to account balance: Unlike a health FSA, DCAPs have no uniform coverage rule. Employees can only be reimbursed up to what they've contributed at the time of the claim.
  • Provider information required: Every claim must include the provider's name, address, and TIN/SSN. Employees report this on Form 2441; missing TIN information creates filing problems for both the employee and the plan.
  • Annual limit: The Section 129 exclusion limit is $7,500 per household for 2026 ($3,750 if married filing separately). The plan document must specify the limit; benefits above it are taxable.
  • Electronic delivery: If communicating electronically, follow DOL safe harbor requirements; employees need regular access to the delivery system and the ability to request paper copies. Protect PII in all claim and election records.
  • Plan Document/SPD and all amendmentsThe original signed cafeteria plan document with DCAP provisions, and each formal amendment (including any adopting the 2026 $7,500 limit). Retain indefinitely; each amendment must be signed and dated before the change takes effect.
  • Annual election formsSigned salary reduction elections for each participant, for each plan year. Retain for at least 6 years.
  • Mid-year change documentationFor each mid-year change: the qualifying event, date, nature of the change, and updated election. Keep in the employee's file.
  • Claims recordsFor each reimbursement: the claim form or TPA record, substantiation documentation (receipt, provider statement), and payment record. Retain for at least 6 years.
  • Nondiscrimination testing workpapersA written record of each year's test calculations: the employee census used, HCI classifications, DCAP election amounts, and pass/fail results for all Section 129 and Section 125 tests. Retain for at least 6 years.
  • W-2 Box 10 reconciliationA reconciliation of DCAP benefits paid and amounts reported in Box 10 for each participant. Retain with payroll records.
  • SPD distribution recordsA log showing when the SPD was provided to each participant.

Common traps

Reimbursing care when the spouse isn't working: If the employee is married, the expense must enable both the employee and the spouse to work or look for work. Care provided while a non-working spouse stays home does not qualify, even if the employee is at work. Exceptions apply when the spouse is disabled or a full-time student.
Prepaying or depositing with a provider: Many daycare centers and au pair agencies require a deposit or advance payment. These are not reimbursable until the care period is actually provided. Reimbursing deposits before services are rendered violates Section 129 reimbursement rules.
Missing or incomplete provider TIN: Every claim must include the provider's TIN/SSN. An exception may apply if the provider can demonstrate they have no TIN, but this is narrow. Missing TIN generally disqualifies the reimbursement and creates problems for the employee's Form 2441 filing.
Not amending the plan document for the 2026 limit increase: The Section 129 statutory limit increased to $7,500 for 2026, but the plan document must be formally amended before employees can elect the higher amount. The statutory change does not automatically update your plan. Without an amendment, your plan limit stays at whatever the document currently states.
Failing the 55% Average Benefits Test because dollar amounts are skewed: Even if HCI and non-HCI participation rates look balanced, the test compares average dollar amounts received. If HCIs max out at $7,500 while non-HCIs elect $500 on average, the test fails. Monitor election amounts, not just headcounts, during the year.

FAQs

What expenses are eligible?

Daycare centers, preschool or nursery school (when primarily for care, not education), before/after-school programs for school-age children, and day camps. Not eligible: kindergarten or higher-grade tuition, overnight camps, tutoring or lessons, or nursing home costs. For a child: eligible through the day before their 13th birthday. For a disabled spouse or dependent of any age: eligible if they live with the employee for more than half the year and are incapable of self-care.

DCAP vs. the dependent care tax credit, which is better?

Employees can't double dip; DCAP benefits reduce the expenses eligible for the dependent care tax credit dollar-for-dollar. For lower-income employees, the credit may actually provide more value than the pre-tax DCAP. Encourage employees to run the comparison before electing; IRS Publication 503 has a worksheet for this.

Can the employer contribute to the DCAP?

Yes. Employer contributions to a DCAP are excluded from employee income (up to the Section 129 limit) and are not subject to FICA taxes. Contributions must be specified in the plan document. Report total DCAP benefits, employer contributions plus employee salary reductions, in Box 10 of the W-2.

Does the DCAP have a uniform coverage rule like the health FSA?

No. Unlike a health FSA, where the full annual election is available on day one, DCAP reimbursements are limited to the employee's current account balance. This eliminates employer financial risk but means employees can't front-load claims early in the year. Communicate this clearly at enrollment so employees understand they need to have contributed before they can be reimbursed.

  • 2026 limit increase, plan amendment required: The One Big Beautiful Bill (signed July 4, 2025) permanently increased the Section 129 exclusion limit to $7,500 ($3,750 married filing separately), effective for plan years beginning on or after January 1, 2026. This is optional; you can keep a lower plan limit, but to allow elections at the higher amount, you must formally amend the plan document before those elections are made. The limit is not indexed for inflation.
  • Divorced or separated parents: A child may be a qualifying person for the custodial parent's DCAP even if the noncustodial parent claims the dependency exemption for tax purposes. The care must still be work-related for the parent claiming the DCAP benefit. See IRS Publication 503 for the specific rules.
  • S-corporation 2%+ shareholders: More-than-2% S-corporation shareholders cannot participate in a DCAP on a pre-tax basis. They are treated as partners rather than employees for Section 125 purposes, and their DCAP contributions would not receive pre-tax treatment.
  • Grace period vs. run-out: DCAP does not permit carryovers. A grace period of up to 2.5 months may be offered if specified in the plan document; this gives employees additional time to incur expenses using prior-year funds. If you offer a grace period, define it clearly in the plan document and communicate it to participants. Most plans use a run-out period only.
  • State income tax treatment: Most states conform to federal Section 129 treatment, making DCAP contributions pre-tax for state income tax as well. New Jersey and Pennsylvania are notable exceptions; confirm state taxability with your payroll provider before the plan year begins.
  • DCAP and health FSA sharing a plan document: If you offer both benefits, they should share the same Section 125 cafeteria plan document with separate DCAP and FSA provisions. Run nondiscrimination testing for each benefit separately; the FSA tests and the DCAP tests use different data, different thresholds, and different testing frameworks.

Tools to help you run DCAP nondiscrimination testing and build your plan document, including a reference to the FSA NDT Worksheet, which covers the Section 125 testing that applies to any cafeteria plan benefit.

Section 125 Cafeteria Plan NDT Worksheet, FSA Page

DCAPs offered through a cafeteria plan are subject to the same three Section 125 nondiscrimination tests as a health FSA: the Eligibility Test, the Benefits & Rights Test, and the Key Employee Concentration Test. The Section 125 FSA NDT Worksheet on the FSA page covers all three; substitute DCAP election amounts for FSA amounts in the Employee Census tab. If your plan includes both an FSA and a DCAP, test each benefit separately using the same census but different election columns.

Note: Section 129 adds four additional tests specific to dependent care (the Eligibility Test, Benefits & Contributions Test, 55% Average Benefits Test, and 5% Owner Limit) that are not covered by the Section 125 worksheet. These are described in the How To Do It section above. Your TPA or benefits advisor can run the Section 129-specific tests alongside the Section 125 worksheet.

Section 125 Plan Document Template, POP Page

The foundational Section 125 cafeteria plan document template is available on the Premium Only Plan (POP) page. To add a DCAP, attach a DCAP addendum covering the annual limit, eligible expenses, claims and substantiation procedures, run-out or grace period, and forfeiture rules. If you already have an FSA plan document, add the DCAP provisions as a formal written amendment to that document rather than creating a new plan.

These tools are for educational purposes and do not constitute legal or tax advice. Consult a qualified ERISA attorney or CPA before finalizing your plan document or relying on test results for tax reporting purposes.