IRS Issues First DCAP Nondiscrimination Guidance in 45 Years
The Internal Revenue Service has issued proposed regulations clarifying the nondiscrimination tests for dependent care assistance programs, including a revised average benefits test and a new correction mechanism for plan failures.
The U.S. Internal Revenue Service has issued proposed regulations under IRC Section 129, providing the first detailed guidance in over 45 years on the nondiscrimination rules for dependent care assistance programs (DCAPs). The guidance clarifies four key tests: the contributions and benefits test, the eligibility test, the owner concentration test, and the average benefits test. This resolves long-standing ambiguities that have made compliance challenging for employers offering these common tax-favored benefits.
Sophisticated counsel and their clients care because the proposed rules introduce important clarifications and favorable changes. Notably, the average benefits test is now calculated using only employees who actually receive DCAP benefits, which may make it easier for some plans to pass. The regulations also establish a formal correction mechanism, allowing employers to address certain test failures by including excess benefits in an individual's taxable income, potentially avoiding the harsher penalty of disqualifying the entire plan for highly compensated employees. Employers may rely on the proposed regulations immediately and should review their current testing procedures and coordinate with plan administrators. The public comment period is open until September 25, 2026.