Change in Pennsylvania Tax Treatment of Dependent Care Expenses

Dependent Care Flexible Spending Account (DCFSA) plans offer a valuable tool for employees to manage childcare expenses while enjoying significant tax benefits. These plans are designed to ease the financial burden associated with dependent care costs, allowing employees to set aside pre-tax dollars from their paycheck to cover eligible dependent day care expenses.

Eligible expenses that can be reimbursed through a DCFSA include childcare services for a child under 13 including preschool, summer day camp, and before or after-school programs. Additionally, expenses related to care for dependents, such as elderly parents or disabled relatives, may also qualify for reimbursement.

Employees may find DCFSA participation appealing for several reasons. It provides a convenient way to budget for and manage childcare expenses by spreading costs evenly throughout the year and the tax savings afforded by DCFSA plans can result in significant financial benefits.

One of the key advantages of DCFSA plans is their tax-favored status for federal income tax purposes. Contributions made by employees to their DCFSA are deducted from their gross pay before federal income taxes are applied, resulting in lower federal taxable income, and reduced federal income tax liabilities. This tax savings can translate into substantial savings for employees throughout the year. Notably, some states recognize the tax-favored status of DCFSA plans and other states do not, thereby impacting the net tax savings of DCFSA participation.

The Commonwealth of Pennsylvania changed its tax treatment of DCFSA participation. Retroactive to the beginning of the 2023 calendar year, Pennsylvania now recognizes the exclusion of up to $5,000 of dependent care benefits from employees’ taxable income. Now, tax treatment of dependent care expenses in Pennsylvania mirrors the federal income tax treatment under section 129 of the Internal Revenue Code.

Employers in Pennsylvania should pay close attention to this new tax change. Since the PA Department of Revenue made this change late in 2023, most employers withheld amounts for Pennsylvania income tax on dependent care assistance plans throughout the year and issued Forms W-2 with the taxable income. Employers should consult their tax counsel to determine if a corrected Form W-2 should be issued to DCFSA participants and for guidance on the tax treatment of DCFSA participation in 2024.

BAS can help administrate flexible spending account plans for organizations of any size. For information about BAS’ FSA services, contact your account manager or solutions@BASusa.com.